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.