Market participants fear revised capital requirements

Legislative changes planned by the US Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation would affect banks with more than $100bn in assets.

US commercial real estate lenders are gearing up for the introduction of more stringent bank capital requirements from the US Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation – and expressing concerns potential changes could stymie what has been a slow recovery for the debt markets.

Upon their proposal in August, the Basel III reforms became the top legislative point of concern for commercial real estate trade organizations, lenders and borrowers alike. With the November 30 open comment period deadline approaching, those voices of concern have only grown louder.

The proposed changes would affect banks with more than $100 billion in assets, forcing some to set aside 16 percent more reserve capital for the loans they originate depending on the size and complexity of the bank lender. 

In a deal environment where debt is already more costly from increased interest rates and more defensive lending stances, such a change would serve as another obstacle to closing during an already volatile time.

Sairah Burki, managing director and head of regulatory affairs and sustainability at New York-based trade group Commercial Real Estate Finance Council, tells Real Estate Capital USA there are many moving pieces in terms of potential impact on the affected banks. “Currently, there is a lot for banks to digest across the proposed new capital requirements for credit, market, and operational risk.” 

Credit risk concerns

Focusing in on credit risk, Burki cites the so-called proposed ‘dual-stack’ requirement – that banks must calculate both the existing and proposed ‘enhanced’ risk-based capital – as one which will introduce unnecessary procedures.  

“Furthermore,” says Burki, “even if certain commercial real estate-specific capital requirements decline, we expect overall bank capital to increase, thereby reducing the appetite for lending.” 

Burki notes the proposal has introduced a more nuanced approach to risk weights for commercial real estate loans, shifting from 100 percent for all non-defaulted exposures to risk-weights ranging from 60-110 percent based on loan-to-value.

For securitizations, on the other hand, the risk weights are generally expected to rise. “However,” Burki continues, “before we assume that banks will unilaterally favor loans over securitizations, we would also note the proposed securitization formula lowers the risk weight floor for securities with more subordination. This means that the security’s ultimate risk-weighting can be lower than under the previous approach.” 

Jeffrey Berenbaum, a director of CMBS strategy at New York-based Citibank, noted in an August research report that the proposed securitization formula could ultimately increase demand for triple-A commercial mortgage-backed securities. These securities will have a 15 percent risk weight under the new proposal and this could incentivize banks to hold more of these assets on balance sheet, he notes.

Berenbaum says that, while Citibank expects real estate loan exposure risk weights to decline under the proposal, the expected rise in capital requirements may push banks to rotate out of loans into securities – reducing risk-weighted asset (RWA) totals by 35-55 percent or more on real estate exposures. 

As an example, Berenbaum says if a bank sells a seasoned multifamily loan with a 5.5 percent coupon and purchases a similar yielding triple-A CMBS, the RWA would drop from 50 percent to 15 percent. 

“If the bank prefers to maintain multifamily exposure, they could purchase agency CMBS at a 4.8 percent yield and drop to a 20 percent risk weight,” Berenbaum notes. He says rotating out of low loan-to-value commercial real estate loans with 70 percent risk weight would see further benefits.

Lending sentiment decline

Ultimately, banks will have to take into consideration securities’ levels of seniority, LTVs, and delinquency trends, and then weigh these against the capital requirements of other potential loans and investments, Burki says.

Concerns of a lending appetite decline are shared at Mortgage Bankers Association, a trade group. MBA president Bob Broeksmit was early to signal disapproval for the reforms in July. 

“Without significant revisions, this proposal will increase borrowing costs and reduce credit availability for the very consumers and borrowers this administration ostensibly seeks to assist,” Broeksmit noted in a release from the MBA. 

“The large increases in capital standards will likely stunt macroeconomic growth and reduce banks’ participation as single-family and commercial/multifamily lenders, servicers and providers of warehouse lines and mortgage servicing rights financing.”

Both CREFC and MBA are taking measures to formulate and send industry feedback to the US regulators involved, which includes the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. 

The trade groups have full plates between the Basel III reforms and other US regulatory proposals. Burki says the SEC has issued proposals related to the private 144A markets and ‘conflicts of interest’ in securitization that, in their current form, could greatly impair commercial real estate liquidity.

By the numbers

Increased bank capital requirements

Global systemically important bank capital requirements will go up 19 percent; non-GSIB banks larger than $250 billion will go up 10 percent; and banks with $100 billion to $250 billion will go up by 5 percent. Regulators expect most banks will already meet these levels.

Regional bank crisis response

The proposal would repeal most of the so-called tailoring for banks with  $100 billion to $250 billion, and subject them to the same standards as most larger banks.

Recognizing unrealized losses

Large banks would have to include unrealized gains and losses from certain securities in their capital ratios.

Market risk capital

Changes to the market risk capital are part of the unfinished Fundamental Review of the Trading Book proposal and will significantly increase capital charges for banks with trading operations.

Standardized approach

The proposal would impose a standard capital charge for credit risks and operational risks, rather than relying on internal bank models.