Basel III Implementation
In July 2013, U.S. banking regulators released the Final Basel III Regulatory Capital and Market Risk Rule, which implemented global standards developed by the Basel Committee on Banking Supervision. 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.
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.
MBA continues to work with our bank portfolio lending members and banking regulatory agencies to address the commercial and multifamily real estate financing issues that arise under these existing or proposed standards.
BASEL III BACKGROUND
Risk-Based Capital for Commercial and Multifamily Loans
As a general matter, for commercial real estate loans held in bank portfolios, the final risk-based capital 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)
The final rule had a major impact on some commercial acquisition, construction, and development loans (ADC loans). Under the final rule, HVCRE ADC loans receive a 12 percent RBC requirement (150 percent risk weight). HVCRE applies commercial ADC with a loan to value of greater than 80 percent, borrower cash contribution of capital less than 15 percent of the project's "as completed" value or insufficient restrictions on withdrawal of capital during the life of the loan. In partial response to bank concerns, the agencies issued a set of FAQs in March 2015.
MBA has expressed our continuing concerns about the HVCRE rule to the Federal Reserve, the Federal Deposit Insurance Corporation and the Comptroller of the Currency. As an alternative solution, MBA has also focused on a possible legislative solution, which contributed to the development of H.R. 2148, a bipartisan bill co-sponsored by Robert Pittenger (R-NC) and David Scott (D-GA), which passed the House by voice vote in November 2017. In February 2018, Sen. Tom Cotton (R-AR) and Doug Jones (D-AL) introduced a Senate version of the bill, S. 2405. HVCRE also may be addressed through a provision in S. 2155, the Economic Growth, Regulatory Reform and Consumer Protection Act, introduced by Senator Mike Crapo (R-ID). The provisions of the bills, if enacted, would clarify the definition of ADC loan, would exempt loans on performing properties that meet underwriting standards for permanent financing, would count the appreciated value of contributed real estate toward the 15 percent requirement, would reduce the required limitations on withdrawal of capital, and would grandfather loans originated prior to January 1, 2015. MBA continues to explore both regulatory and legislative paths.
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 US regulators should conduct a comprehensive study of the impact of the proposal and other new rules to determine their impact on credit availability before issuing any final rule. We cautioned that the Net Stable Funding Ratio would need to 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 elements of its prior 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.
In March 2017, the Committee issued a revised "near final" Proposal. The Proposal would considered by U.S. regulators only after it has been finalized by the Basel Committee. MBA submitted a comment May 15 recommending that the Committee explicitly grant US regulators and other national supervisors the flexibility necessary to avoid imposing capital, liquidity or other requirements that are not warranted by actual risks and to avoid imposing a duplicative layer of regulation.
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). If adopted by U.S. regulators, the approach described in the Consultative Document 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, as described above, and to strongly oppose onerous new regulatory requirements as they arise, including the Basel Committee's Step-in Risk and Fundamental Review of the Trading Book Proposals.
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