Basel III Implementation
In July 2013, U.S. banking regulators released the Final Basel III Regulatory Capital and Market Risk Rule. The final rule became effective on January 1, 2014, and many of the sections impacting commercial real estate mortgages and securities were implemented on January 1, 2015. MBA continues to work with our bank portfolio lending members and banking regulatory agencies to address implementation issues and seek clarification where necessary. In addition to Basel III, the Basel Committee has ongoing work streams that, if adopted by U.S. regulators, could have negative impacts on commercial and multifamily real estate financing. As discussed below, MBA expresses strong concerns over some of these work streams.
BASEL III BACKGROUND
Risk-Based Capital for Commercial and Multifamily Loans
For commercial real estate loans held in bank portfolios, the final rule had negligible impact when it became effective. The final rule maintained the 8 percent risk-based capital (RBC) requirement (100 percent risk-weight) for bank mortgages for existing properties (non-construction mortgages) that are held in portfolio. For multifamily loans that meet certain underwriting conditions, RBC was reduced from 8 percent (100 percent risk weight) to 4 percent (50 percent risk weight).
High Volatility Commercial Real Estate Exposures (HVCRE)
Under the final rule, HVCRE commercial real estate loans receive a 12 percent RBC requirement (150 percent risk weight). HVCRE applies to only acquisition, construction, and development loans (ADC loans) with a loan to value of greater than 80 percent and when the contributed capital from the borrower is less than 15 percent of the project's "as completed" value. Since MBA's meeting on HVCRE with the Federal Reserve, the Federal Deposit Insurance Corporation and the Comptroller of the Currency (the agencies) in 2015, MBA has continued to work closely with the agencies to address our HVCRE concerns. Since January 2015, MBA has provided six submittals to the agencies in support of needed modifications to conform the final rule to customary and prudent operational practices of banks. MBA is also working to support a possible legislative approach to addressing these areas of concern.
GSE Multifamily MBS
For multifamily MBS that are guaranteed by Fannie Mae and Freddie Mac, the final rule maintained the existing 1.6 percent RBC requirement (20 percent risk weight) and the "substitution approach" that allows this RBC charge to be applied to the multifamily tranches that Fannie Mae and Freddie Mac guarantee.
Mortgage Servicing Rights
MSRs were not given favorable treatment in the final rule. The rule requires banks to deduct from the common equity component of tier 1 capital: mortgage servicing rights, deferred tax assets, and common stock purchases of unconsolidated financial institutions that individually exceed 10 percent of the common equity component of tier 1 capital. In addition, banks must deduct the aggregate of all assets in the above categories that exceed 15 percent of the common equity component of tier 1 capital from the common equity component of tier 1 capital. Any MSRs not deducted from capital receive a risk weight of 250 percent (a 20 percent capital requirement). This is a substantial increase from the prior 100 percent risk-weight for MSRs (8 percent capital requirement). The final rule allows for a five year phase-in, commencing January 1, 2014. MBA and its coalition partners strongly oppose this treatment of MSRs and continue to seek modifications to the current rule.
Simplified Supervisory Formula Approach (SSFA)
The Simplified Supervisory Formula Approach (SSFA) is a formula-based approach for calculating RBC. Consistent with the Dodd-Frank Act's bar on regulator reliance on ratings, the SSFA replaces the ratings-based approach that had previously applied under the rule.
The SSFA will generally not increase RBC for the most senior CMBS tranches. For CMBS with subordination levels of 30 percent or greater, the SSFA will maintain the 1.6 percent RBC charge (20 percent risk-weight). This means that for CMBS bonds that comprise the top 70 percent of the CMBS waterfall structure, the SSFA will not result in increased RBC. However, for CMBS bonds with Junior AAA (less than 30 percent subordination levels), AA, A, BBB ratings, the SSFA will generate significantly higher RBC requirements. MBA recommends that the banking regulators recalibrate the SSFA to be less punitive on Junior AAA and AA securities.
Additional Basel Committee Work Streams
Liquidity Coverage Ratio
In September 2014, the banking agencies issued the Liquidity Coverage Ratio (LCR) final rule. The LCR is a supplementary rulemaking to Basel III that creates a new bank liquidity measure - LCR. The LCR is intended to ensure that large banks hold sufficient stock of "high quality liquid assets" to survive a specified liquidity stress scenario. The final rule was responsive to MBA's comment letters by eliminating the highly detrimental treatment of Special Purpose Entities (SPEs), and it provided important clarifications regarding the unfunded portions of commercial real estate development loans and acquisition credit facilities. However, MBA had opposed the LCR treatment of CMBS adopted in the final rule and has recommends additional changes so that CMBS no longer on a bank's balance sheet would be excluded from the LCR calculation.
Net Stable Funding Ratio
The Net Stable Funding Ratio requirement would require banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities. The Basel Committee finalized its Net Stable Funding Ratio proposal in December 2014, and U.S. regulators issued a Net Stable Funding Ratio proposed rule in May 2016. In comments on the proposed rule, MBA recommended that, prior to issuing a final rule, US regulators should conduct a comprehensive study of the impact of the proposal and other new rules to determine their impact on credit availability The Net Stable Funding Ratio be carefully calibrated to avoid any unintended consequences for U.S. banks that could adversely affect bank support of the CRE industry.
Standardized Approach for Credit Risk
In March 2016, MBA submitted its second comment letter on the Basel Committee's Consultative Document on the Standardized Approach to Credit Risk. Under the most recent Consultative Document, bank capital charges for most commercial and multifamily real estate loans would not be changed. MBA's letter commends the Basel Committee for withdrawing its proposal that would have imposed punitive capital treatment for loans for commercial real estate properties that were organized as Special Purpose Entities (SPEs). MBA also supported the withdrawal of the proposal that would have established the capital charge for all CRE loans based solely on the credit profile of the borrower, not the property. The Consultative Document will not be considered by U.S. regulators until after it has been finalized by the Basel Committee. Provided that the Credit Risk proposed rule by U.S. regulators reflect MBA's recommended changes, MBA would not oppose it.
In March 2016, MBA submitted a comment letter addressing the Basel Committee's Step-in Risk Consultative Document (Proposal). Step-in risk involves the risk that a bank may provide financial support to an entity beyond or in the absence of any contractual obligations, should the entity experience financial stress. The Proposal called for a new capital regime to address step-in risk. MBA strongly opposed this Proposal because step-in risk is, among other things, adequately addressed by existing accounting rules. The Committee issued a revised "near final" Proposal in March 2017, which MBA is reviewing. The Proposal will considered by U.S. regulators after it has been finalized by the Basel Committee. MBA recommends that U.S. regulators not consider the Proposal.
Fundamental Review of the Trading Book
In January 2016, the Basel Committee issued its final Consultative Document on the Fundamental Review of the Trading Book (FRTB). The FRTB rules could negatively impact securitized products. If adopted by U.S. regulators, this approach would dramatically increase capital requirements for bank trading book activities for CMBS and other structured securities. In November 2015, MBA participated in a coalition letter to US regulators that strongly recommended that they work to make modifications to the FTRB proposal -- in advance of the U.S. regulatory agency consideration -- in order to avoid negative impacts on the U.S. market. MBA recommends that U.S. Regulators not adopt the FRTB proposal.
MBA is engaging in comprehensive regulatory and Congressional strategy to address the problematic elements of the HVCRE final rule and to strongly oppose the Basel Committee's Step-in Risk and Fundamental Review of the Trading Book Proposals.
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