Basel III Capital Accords
In June of 2012, the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued proposals intended to implement new international banking standards, known as the Basel III Capital Accords, promulgated by the Basel Committee on Banking Supervision. Banks utilize the framework established by the Basel Committee to calculate the amount of regulatory capital they must hold against specific types of loans they hold on their books. The new Basel III standards could have a significant negative impact on lending by banks to the commercial real estate sector. Several aspects of the new standards would have harmful effects on the availability and cost of credit to commercial, multifamily, and single-family residential real estate borrowers and to the U.S. economy as a result.
In June 2012, the Federal Reserve, the Office of the Comptroller of the Currency “OCC”), and the Federal Deposit Insurance Corporation (“FDIC”) issued proposals intended to implement new international banking standards, known as the Basel III Capital Accords, promulgated by the Basel Committee on Banking Supervision. Banks utilize the framework established by the Basel Committee to calculate the amount of regulatory capital they must hold against specific types of loans they hold on their books. Over the years, there have been several stages of Basel Accords, with the first (“Basel I”) being agreed to in 1988 to ensure that banks held more capital for high risk loans, and the second stage, Basel II, finalized in 2007. The current Basel III proposals were developed in the wake of the 2008 worldwide financial crisis, to replace the current capital adequacy and liquidity standards.
Over the long term, the standards which became effective for all banks in 2015, could have a significant negative impact on lending by banks to the commercial real estate sector. The accords force banks to assign higher risk weights for acquisition, development, and construction (“ADC”) loans, now defined as High Volatility Commercial Real Estate (“HVCRE”) loans, despite the fact that the underwriting for commercial real estate had been well-managed with prior existing risk-ratios. HVCRE loans are given a risk weight of 150 percent as compared to other loans, forcing banks to hold more capital against their real estate lending. For commercial loans, in order to avoid the HVCRE designation, a borrower would have to fulfill certain requirements in addition to meeting applicable loan-to-value requirements:
- The borrower must contribute cash (or unencumbered marketable assets), or has paid development expenses, equal to 15% or more of the appraised “as completed” value of the project;
- The borrower must contribute the 15% before any funds are advanced by the bank;
- Capital contributed by the borrower, and any internally-generated funds by the project, must be kept in the project until converted to permanent financing, sold or paid in full.
Land contributions must be valued by the bank at the property’s original cost, not at its current market value. In addition, loans in existence before the effective date of the regulation are not exempted from the application of the new capital requirements, leaving open the question as to whether a bank may try to require additional equity from the borrower to avoid the increased capital charge.
At the time they were promulgated, NAIOP and its real estate allies opposed the proposals, submitting a comment letter raising and detailing our concerns. NAIOP and its real estate allies also submitted a letter to the House Financial Services Committee and a letter to the Senate Committee on Banking, Housing and Urban Affairs in preparation for hearings on implementation of the Basel III accords.
The proposed standards were delayed until 2013, and went into effect for all banks on January 1, 2015. In an attempt to clarify the confusion caused by implementation of the new standards, the banking regulators issues a “Frequently Asked Questions” document in April 2015. The new guidance did not address the concerns raised by the industry. NAIOP and itss allies have been educating members of the House Financial Service Committee and Senate Banking Committee, with a the goal of increasing their oversight of regulators as they implement Basel III standards.
NAIOP opposes the capital regulations in their current form since they impose additional restraints on bank lending to the commercial real estate sector, even though this sector was not a contributing factor to the 2008 banking crisis.
- The regulations could have harmful effects on the long-term availability of bank lending and cost of credit to several sectors of the real estate industry, including the commercial real estate industry. The banking regulators have not properly assessed the impact that the new standards would have on bank lending to commercial real estate, and its subsequent impact on the U.S. economy.
- While banking organizations suffered losses in the real estate market during the financial crisis, losses in the commercial asset class were limited and related to the economic downturn, not to any underwriting problems associated with commercial real estate projects. The increase risk weights given to commercial real estate lending in the new standards, including the creation of the new “HVCRE” designation, do not arise from any existing structural issues that led to the crisis.
- Commercial real estate continues to contribute to economic growth. Credit to commercial real estate nearly shut down in 2008 and began to return only in 2010. We should not allow another contraction in credit availability to arise as a result of an unnecessarily broad regulatory measure.
- Congress should exercise it oversight authority over the banking regulators, and closely monitor the impact of these new standards on lending to commercial real estate.
High Volatility Commercial Real Estate (HVCRE) Exposures FAQs
Letter to the House Financial Services Committee
Letter to the Senate Committee on Banking, Housing and Urban Affairs