Basel III Implementation
In July 2013, U.S. banking regulators released the Final Basel III Regulatory Capital and Market Risk Rule. While the final rule became effective on January 1, 2014, 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 increase bank capital requirements for commercial and multifamily real estate loans. 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 has negligible impact. The final rule maintains 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 would be reduced from 8 percent to 4 percent.
High Volatility Commercial Real Estate Exposures (HVCRE)
Under the final rule, HVCRE commercial real estate loans will receive a 12 percent RBC charge (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.
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 charge (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 that 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 be deducted from the common equity component of tier 1 capital. In addition, the aggregate of all assets in the above categories that exceed 15 percent of the common equity component of tier 1 capital must be deducted from the common equity component of tier 1 capital. Any MSRs not deducted from capital would be risk-weighted at 250 percent. The present risk-weight of MSR's is 100 percent. 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 that replaces the ratings-based approach in which RBC was assigned based on the credit rating of the purchased tranche.
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 SSFA be recalibrated to be less punitive on Junior AAA and AA securities.
ADDITIONAL BASEL COMMITTEE WORK STREAMS
Liquidity Coverage Ratio
In September 2014, the Liquidity Coverage Ratio (LCR) final rule was released. 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. MBA opposes the LCR treatment of CMBS and has recommended that CMBS no longer on a bank's balance sheet be excluded from the LCR calculation.
Net Stable Funding Ratio
The Net Stable Funding Ratio requires banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities. U.S. regulators are working on their version of this rule and we may expect to see the Net Stable Funding Ratio proposed rule in 2016. The Basel Committee finalized its Net Stable Funding Ratio proposal in December 2014. MBA recommends that the Net Stable Funding Ratio be carefully calibrated to avoid any unintended consequences for U.S. banks.
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 calls for a new capital regime to address step-in risk. MBA strongly opposes this Proposal because step-in risk is, among other things, adequately addressed by existing accounting rules The Proposal will not be considered by U.S. regulators until 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 that strongly recommended 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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