Category: Capital and Credit

Federal bank regulators this week approved a sweeping set of proposed changes that would increase capital requirements for the nation’s largest banks by as much as 20%, which could significantly affect liquidity available for commercial real estate transactions, impact asset values, and influence economic growth. Dissenting votes on the proposed rulemaking revealed rare disagreement among regulators, and Fed Chairman Jerome Powell signaled a cautious approach to consideration of any final rule as a 120-day public comment period begins. (Axios and PoliticoPro, July 27)

New Capital Framework

• The Fed, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) jointly approved the proposal, which would substantially revise the regulatory capital framework for banking organizations with total assets of $100 billion or more. Stakeholder comments on the 1,100-page proposed rulemaking are due by Nov. 30. (See Interagency Overview of the Notice of Proposed Rulemaking for Amendments to the Regulatory Capital Rule, July 27)

• Fed Chairman Powell voted for the proposal, but noted a significant tone of caution, stating, “Raising capital requirements also increases the cost of, and reduces access to, credit … threatening a decline in liquidity in critical markets and a movement of some of these activities into the shadow banking sector.” He added, “While there could be benefits of still higher capital, as always we must also consider the potential costs. As the financial system evolves, it is important that regulation evolve with it. I look forward to hearing from all stakeholders on how best to strike that balance.” (Federal Reserve Board – Statement by Chair Jerome H. Powell)

• Statements were also issued by Fed Governors Michelle W. Bowman and Christopher J. Waller, who voted against the proposal. Extensive background information on the proposal is available on the Fed’s website, including a video of the Fed’s July 27 Open Board Meeting, Board memo, Fact Sheet, Statements and Federal Register Notices.

• The proposed changes to large bank capital requirements would implement the final components of international banking regulations known as the Basel III “endgame” following the U.S. banking turmoil in March 2023. The agencies’ proposal would have a long phase-in period and not impact community banks. (CNBC, July 27)

• Real Estate Roundtable President and CEO Jeffrey DeBoer stated in a March 2023 comment letter to Fed Vice Chair Michael Barr and other key regulators, “At this critical time, it is important that the Agencies do not engage in pro-cyclical policies such as requiring financial institutions to increase capital and liquidity levels to reflect current mark to market models. These policies would have the unintended consequence of further diminishing liquidity and creating additional downward pressure on asset values. A deflationary spiral must be avoided at all costs. As recent events are only amplifying the contraction of credit, it is important for the Agencies to take measures to maintain sufficient liquidity levels and support positive economic activity.”

CRE Challenges

• The Wall Street Journal this week quoted Roundtable Chair John Fish, above, (SUFFOLK Chairman and CEO) and Roundtable Board Member Scott Rechler, (RXR Chairman and CEO) on the influence of the agencies and their positive joint policy statement issued last month that granted flexibility for CRE workouts. Agencies’ joint statement, June 29 and Roundtable Weekly, June 30)
• Fish noted that the agencies’ recent policy statement “is a bridge to the other side. It’s what the real-estate industry was asking for.” Rechler also praised the new policy and added, “Since the failure of the regional banks, regulators have come on very hard.”
• Major refinancing pressures facing CRE are shown in new Trepp data released this week, which estimates $528.7 billion of commercial mortgages will mature this year—and increase to $532.8 billion next year. (TreppTalk, July 25)
• Trepp notes the data indicates “the market is facing a wall, if not a mountain, of maturities that would make the 2015-2017 wall of maturities look almost inconsequential. During that period, roughly $1.1 trillion of loans were scheduled to come due.”

The Roundtable’s Real Estate Capital Policy Advisory Committee (RECPAC) plans to work on industry comments in response to the agencies’ proposed rulemaking.

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Banks are increasing their efforts to modify troubled commercial real estate loans to prevent defaults, according to recent media reports. (GlobeSt  and Bisnow, July 14)

Momentum on Modifications

• “Lenders are offering borrowers loan extensions and modifications, selling derivatives to fix interest costs, and offering subsidized loans to investors to purchase defaulted loans” according to CRE analysts and industry data quoted by Reuters on July 12
• The reported increase in modifications follows a joint policy statement from federal regulators last month that encouraged financial institutions to work with borrowers on pending loan maturities. (Agencies’ joint statement, June 29 and National Law Review, July 9)
• Real Estate Roundtable President and CEO Jeffrey DeBoer commented on the positive action by regulators. “This major step forward by federal regulators provides the flexibility that The Roundtable has consistently encouraged, and the relief many in the industry need, as the economy and communities struggle to move beyond the repercussions of the global pandemic,” DeBoer said. (Roundtable Weekly, June 30 and Roundtable letter to regulators, March 17)

Need for Liquidity

• On July 20, Roundtable Chair John Fish (SUFFOLK Chairman and CEO) discussed the pressures facing CRE and the recent policy accommodation from regulators on Bloomberg’s What Goes Up podcast. “The biggest problem right now is the capital markets nationally have frozen,” Fish said.
• On July 14, Roundtable Board Member Scott Rechler, above, (RXR Chairman and CEO) joined CNBC’s Closing Bell Overtime to discuss the impact of the credit crunch and the need for more liquidity in the market. (Watch interview)
• A July 6 article by Carl White, senior vice president of the St. Louis Fed’s Supervision, Credit and Learning Division, shows that the proportion of nonperforming CRE loans remains low on an average basis and has continued to decline since 2020.

Low occupancy rates for downtown offices in various cities are leading municipal governments to incentivize adaptive reuse by encouraging the conversion of often-older office buildings into residential properties. A report this week from RentCafe forecasts that conversions may increase by 63% in coming years, after adaptive reuse peaked from 2019 to 2020. (GlobeSt, July 19)

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In a positive development for the commercial real estate industry, federal regulatory agencies issued a joint policy statement yesterday on CRE loan accommodations and workouts that calls for “financial institutions to work prudently and constructively with creditworthy borrowers during times of financial stress.” (Agencies’ joint statement, June 29) 

Real Estate Roundtable President and CEO Jeffrey DeBoer, above, said, “We enthusiastically welcome and applaud the action of federal regulators to accommodate commercial real estate borrowers and lenders as the industry endures a time of historic, post-pandemic transition. Maturing office loans in particular face a new environment of higher operating and financing costs, much tighter bank lending requirements, and uncertainty in business space needs. This major step forward by federal regulators provides the flexibility that The Roundtable has consistently encouraged, and the relief many in the industry need, as the economy and communities struggle to move beyond the repercussions of the global pandemic.”

CRE Relief 

• This significant action fulfills recent Real Estate Roundtable requests for regulators to provide more supervisory flexibility that would allow for the responsible restructuring of maturing CRE loans. The guidance is expected to encourage debt restructuring for certain office assets under pressure from remote work, high interest rates, and post-pandemic demand. (Roundtable Weekly, May 11 | Roundtable letter to regulators, March 17)
  
  
• The June 29 joint agency statement was issued by the Office of the Board of Governors of the Federal Reserve System (the Fed), the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), and National Credit Union Administration (NCUA).
  
  
• The agencies noted that their policy statement builds on existing supervisory guidance issued in 2009, updates existing interagency supervisory guidance on commercial real estate loan workouts, and adds a section on short-term loan accommodations.
  
  
• The new section on accommodations includes an agreement to defer one or more payments, make a partial payment, or provide other assistance or relief to a borrower who is experiencing a financial challenge. The statement also addresses recent accounting changes for estimating loan losses and provides examples of how to classify and account for loans affected by workout activity. (See 90-page policy statement on “Prudent Commercial Real Estate Loan Accommodations and Workouts”)
  
  
• Approximately $1.5 trillion in CRE mortgages will mature in the next three years were originally financed when base rates were near zero. Refinancing this wave of maturing loans is complicated by the current debt environment, characterized by much higher interest rates, uncertain asset values, and illiquid capital markets. 

CRE Part of Fed Stress Test 

• This week, the Federal Reserve also released the results of its annual bank stress tests, which included a severe hypothetical scenario of global recession, a 40% decline in commercial real estate prices, a substantial increase in office vacancies, and a 38% decline in house prices. The Fed noted the stress test focus on CRE illustrates that 23 large banks would be able to continue lending in the hypothetical scenario, despite heavy losses. (2023 Fed stress test results and CNBC, June 28)
  
  
• “Today’s results confirm that the banking system remains strong and resilient,” Vice Chair for Supervision Michael S. Barr said. “At the same time, this stress test is only one way to measure that strength. We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.” (Fed news release, June 28)
  
  
• The 2023 adverse test scenario model stated that declines in CRE prices should be assumed to be concentrated in properties most at risk of a sustained drop in income and asset values—offices that may be affected by remote work or hospitality sectors that continue to be affected by reduced business travel.
  
  
• The Fed’s stress test report added, “The May 2023 Financial Stability Report highlighted elevated prices on CRE and the possibility of a large correction in property values that could lead to substantial losses for banks. The demand for offices, downtown retail, and hotels has seen dramatic and countervailing changes over the past several years due largely to the pandemic and resulting changes. While many bank CRE loans are held by smaller banks not subject to the supervisory stress test, the banks subject to the stress test hold approximately 20% of office and downtown retail CRE loans.”
  
  
• Regulators have also recently signaled they are likely to adopt increased capital requirements for the nation’s biggest banks, while Fed governor Michelle Bowman this week spoke out against tougher regulations. (Axios, June 21 and June 26) 

“We need to consider whether examiners have the appropriate tools and support to identify important issues and demand prompt remediation,” Bowman stated. “Increasing capital requirements simply does not get at this underlying concern about the effectiveness of supervision.” She added, “It is abundantly clear that regulatory and supervisory reform is on the way.” (Bowman speech and Bloomberg, June 25) 

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