The Federal Reserve Board this past week invited comment on three proposed rules that would revise the methods for calculating risk-weighted assets for certain exposures and would increase the amount of capital that banks would be required to maintain.
Taken together, the proposals would implement in the United States the Basel III regulatory capital reforms from the international Basel Committee on Banking Supervision and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
For some "high-volatility commercial real estate
" exposure, the Fed would require banks to assign a 150% risk weight, which increases the current risk weight of 100%. The Fed said the proposal would "address weaknesses that have been identified over the past several years."
Share this story with your followers here.
"Supervisory experience has demonstrated that certain acquisition, development, and construction loans exposures present unique risks for which the agencies believe banking organizations should hold additional capital," the Fed proposals state.
Accordingly, the federal banking agencies propose to require banking organizations to assign a 150% risk weight to any high volatility commercial real estate exposure (HVCRE). The proposed definition of an HVCRE would be a credit facility that finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances: one- to four-family residential property; or finances a commercial real estate projects in which: The LTV [loan-to-value] ratio is less than or equal to agency lending standards or the borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15% of the real estate's appraised "as completed" value.
Non HVCRE loans would continue to be assigned a risk weight of 100%.
The Federal Reserve's proposal is credit positive, said Rita R. Sahu, vice president - senior analyst of Moody's Investors Service, but It "misses residential construction."
"Of particular significance is that the Federal Reserve increased the risk weighting of "high volatility" commercial real estate (CRE), including certain acquisition, development, and construction loans, to 150% from 100%. This is positive because this asset class historically has resulted in very sizable losses for US banks. However, the exclusion of one-to-four-family construction in the NPR's definition of high volatility CRE dilutes this benefit materially," Sahu wrote in a special comment.
"Residential construction was a significant contributor to the asset woes of regional U.S. banks during the financial crisis. Acquisition, development, and construction nonperforming assets, which include residential construction loans, reached a staggering 21% of construction loans in first-quarter 2011, while net charge-offs in this portfolio peaked at a high 8%. Residential construction loans drove this deterioration, as they fell victim to the housing surplus, and the loss severity was extreme," Sahu said.
"Construction lending has been the most meaningful business for small community banks. Small community banks with assets of $10 billion and less have about 21% of the entire banking system's assets, but about 48% of the system's construction loans as of 31 March 2012," he said.
For big banks whose CRE exposure is far lower, the NPRs have no immediate implications because the capital demands of Basel III have essentially been in effect for two years, Sahu said.
"Capital is important to banking organizations and the financial system because it acts as a financial cushion to absorb a firm's losses," Federal Reserve Chairman Ben Bernanke said. "With these proposed revisions, banking organizations' capital requirements should better reflect their risk profiles, improving the resilience of the U.S. banking system in times of stress, thus contributing to the overall health of the U.S. economy."
The Federal Reserve is requesting public comments on the proposal by Sept. 7, 2012.
Keep up weekly on national news, trends and property leads with the Watch List Newsletter,
a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert
. A new issue is published late each Wednesday.