Senate Banking Committee Chairman Mike Crapo (R-ID) said yesterday he's more optimistic about gaining bipartisan support for housing finance reform than on some of the more controversial areas of financial deregulation, such as the CHOICE Act.
“Housing finance is one of those areas that has greater potential than many of the others,” Crapo said, speaking at a Women in Housing and Finance event in Washington (CREFC’s Christina Zausner is a member of the group). Crapo also alluded to a separate economic growth package that could include modest regulatory reforms. This likely stems from Crapo and Ranking Member Sherrod Brown (D-OH) convening a hearing in March that sought to create legislative vehicles that would “enable consumers, market participants and financial companies to better participate in the economy.”
Crapo also said there was a “heavy, busy agenda” in the Senate, including government funding, health care, tax reform and Administration nominations. His expectation was that any other legislation would be pushed into late fall and perhaps into next year.
On the ancillary banking reform initiatives, Crapo referred to one of former Federal Reserve Gov. Daniel Tarullo's parting speeches, in which he made recommendations including raising the $50 billion threshold for enhanced prudential standards, easing stress test requirements, simplifying the Volcker rule and streamlining small-bank capital rules.
Step-In Risk (SIR) did not fade away as the industry had hoped. It is back and ready to become policy now that the Basel Committee on Banking Supervision (BCBS) published its second consultative document (CD) on March 15.
What Is SIR?
SIR is the second derivative of reputational risk. Regulators believe that where there is reputational risk, there may also be SIR. In the case of CMBS, SIR occurs if sponsor bank choses to provide economic support to sponsored, but unconsolidated entities. For those who are not familiar with reputational risk, it encompasses all things that could inflict damage to a bank’s franchise, but some specific examples are public regulatory actions (such as cease-and-desist orders and fines), litigation, and….widespread defaults of bonds.
Why SIR Is Out of Step with Other Policy Themes?
Improving economic growth is an issue both Republicans and Democrats see eye-to-eye on in the legislature and reducing regulatory burden is one of the solutions that some are considering. With these themes in mind, the addition of SIR by the BCBS to its agenda on top of a regulatory framework that already addresses reputational risk is dissonant with the prevailing themes of the day.
What Does the CD Require?
The SIR CD is simply another self-assessment requirement. It does not assess automatic capital and/or liquidity charges, but it does hold them out as a potential remediation if SIR is deemed to be a material risk.
Why Do We Care?
There have been previous supervisory exercises that begin, much like SIR, as requests for data and analysis. Sometimes the regulators’ assessments of these requests turn out differently than the banks’. It is fair to say that the Fed-led stress tests and capital reviews start out as requests for information, and end with the banks and the regulators disagreeing on the facts. In a worst-case scenario, these ‘exercises’ could trigger additional capital and liquidity charges for off-balance-sheet CMBS.
In the case of the second SIR CD, the definitions of the risk factors seem so broadly written that SIR could be deemed to be present based on relatively little - or even no risk - of such an event. The question of investor appropriateness, in particular, could be an issue in the case of CMBS. Though CMBS are sold to qualified investors, the reference in the CD (section 3.8 on page 10) indicates that the determination as to the appropriateness of the investor is to be based on an investor’s “risk appetite”, which is an unspecified concept without legal underpinnings.
What Comes Next?
If all goes according to plan, the BCBS will finalize its requirements quickly and then home country regulators then decide whether or not to tailor and promulgate rules for their national jurisdiction. In the U.S., all capital rules promulgated by the Federal Reserve, FDIC and OCC must be put through the notice-and-comment process so the industry can provide feedback. The BCBS is targeting 2019 for implementation.
CREFC signed an industry letter when the BCBS issued its first CD on SIR in December 2015. We and other trade associations argued then that the current regulatory framework is more than sufficient to surface material risks and to counterbalance them with capital and liquidity requirements. CREFC is working with CREFC Europe, the Real Estate Roundtable, and possibly other trade associations to file a comment letter for the second CD. To hear more about the effort and/or to provide feedback, please contact me at firstname.lastname@example.org or 202-448-0851.
As we alluded to in last Friday’s (03-24-17) Week in Washington, the House of Representatives was stuck shy of the majority of votes needed on a bill to repeal and replace the Affordable Care Act (aka ‘Obamacare’). The vote was canceled – not to be rescheduled. The President not soon after declared that particular effort dead and said he was eager to move on to tax reform.
The road to Friday’s ultimate rebellion was the antithesis of what Republicans campaigned on in the wave election of 2010, and again in 2016. They said Obamacare was secretly written in the back room by party leadership, brought to the floor hastily, lacked a real Congressional Budget Office (CBO) score for cost evaluation and was unfamiliar to both the Congressmen voting and the constituents they represented. In the end, the Republicans unwittingly copied the Democrat playbook almost to a tee. They violated the very same mantras they ran on in 2010 and that proved a bridge too far for more than two dozen of the members, and likely many more had a true vote of conscience been taken.
In the end, it was a huge setback for President Trump (pardon the use of his favorite word) and the Speaker. Not only was it a stinging symbolic defeat on one of his signature issues – indeed, one of the caucus’ signature issues – it was very much a key component to his pro-growth tax reform plan.
So, how is health care repeal a key element of tax reform? At its core, Obamacare relied on a series of fees (or ‘taxes’ as the Supreme Court later ruled) to fund the subsidies required to assist the low income purchase of health insurance or to support state Medicaid programs. Initially, Speaker Paul Ryan (R-WI), one of the chief architects of tax reform, had the repeal of the Affordable Care Act scored as ‘saving’ about $1 trillion over 10 years. This re-arced the so-called ‘tax baseline’ for the purposes of the tax reform debate. Since the party wanted to lower the corporate tax rate 10 percentage points, they needed that “pay-for” (along with the highly controversial border adjustment tax, or ‘BAT’) to come up with the $2 trillion that would allow tax reform to score as revenue-neutral over 10 years.
Without the repeal of Obamacare, Speaker Ryan now has a $1 trillion hole to plug if he, the President or the caucus insist on a revenue-neutral package. We suspect those leadership-aligned, moderate Republican voices would quickly become recalcitrant fiscal hawks for fear of being ousted in a primary next year. This brings President Trump to a fork in the road: Does he consolidate the party and pass large reforms on party-line votes, or look past the 25 or so House Freedom Caucus members hell bent on voting ‘no’ to everything and begin working with Democrats? Recent statements suggest the latter.
As the nation’s dealmaker-in-chief, Trump can fulfill one of his campaign slogans by reaching across the aisle and grabbing 30-40 moderate Democrats from states very much in play in 2018 and 2020. It appears as if he may use infrastructure funding as a means to lure Democrats to the table on tax reform.
To be sure, obstacles are in clear view: the Supreme Court vacancy, a two-week April recess, government funding that expires April 28, another budget deal needed in May and a host of nominees to push through the Senate under adversarial and time-wasting rules. What could usher in this utopia of bipartisanship? A bill that unites members by something other than party affiliation…
Flood insurance is the next priority on the House Financial Services Committee calendar (the program expires September 30). We were told just days ago that the bill is nearly complete and almost ready for mark-up. And, during the last hearing we heard encouraging words from the Chairman for a multi-year reauthorization. Readers will recall the Chair’s less-than-enthusiastic words at the start of the terrorism insurance reauthorization effort. Since the Chairman is coming at this effort from a pro-reauthorization stance, we are bullish for an on-time renewal ahead of expiration.
Could the flood bill be what breaks the dam of partisanship gridlock in Washington? We shall see, but many other efforts are increasingly dependent on Democrats voting with the majority to push signature priorities over the finish line, such as infrastructure, tax reform and immigration reform. 2017 promises to be a whirlwind ride that’s only just getting started.
On March 13, 2017, Thomas Hoenig, the FDIC’s Vice Chair, formally introduced an outline of his plan for revising the regulatory framework for banks. It includes relief for community banks and a 21st century version of the Glass-Steagall Act, as well as some significant relief for large banks that maintain ‘heroic’ levels of capital. For a fuller summary, see Isaac Boltansky’s (Compass Point) write-up (attached).
When the FDIC first approached the subject in 2015, the potential for realization of Hoenig’s plan was relatively low. Then, in July 2016, the House Financial Services Committee Chairman, Jeb Hensarling (R-TX), put forward the Financial CHOICE Act, which bore unmistakable similarities to Hoenig’s plan. Still, the CHOICE Act was thought of as a messaging piece in an election year, and again, the Hoenig-Hensarling plan seemed to have only a remote probability of success.
Hoenig’s reissued detailed blueprint, which comes one week after the Trump Administration reiterated its commitment to the Glass-Steagall concept, makes the potential for passing a capital-heavy plan for big banks seem more realistic. By all accounts, the second round of the CHOICE Act due out in the near future will retain the bones previewed in v1 and in the Hoenig plan. If the Choice Act v2 includes the 21st century Glass-Steagall piece that the Hoenig plan introduced earlier this week, there is a significant chance that a broad bank reform bill could actually attract bi-partisan support.
In light of the fact that this regulatory reform blueprint now has a shot at becoming a signed bill, here are some questions the Hoenig plan raises:
1. Similarities and Differences between the Hoenig Plan and the CHOICE Act
Both plans share similarities in their approaches to capital for large banks and relief for community banks, but there are differences in their treatment of broker-dealer activities. The scope of the CHOICE Act is broader, as it also covers regulations that apply to insurers, credit unions and rating agencies.
Outwardly, the differences in treatment of broker-dealer activities appear to be significant, when in fact, they may be more tactical than anything. While both plans effectively allow banks that maintain high levels of capital to be excluded from Volcker, the Hoenig model also implements the new Glass-Steagall-type division between banking and trading businesses. Hoenig’s version of Glass-Steagall requires restructuring, but both plans allow bank broker-dealers to remain under the same parent company and to manage secondary-market liquidity more flexibly than currently is possible.
Additionally, the CHOICE Act v1 featured a repeal of the risk-retention rule, except for residential mortgages. The Hoenig plan does not mention risk retention, reinforcing the central mission of his blueprint—bank resolvability. While the CHOICE Act also addresses the question of ‘Too-Big-To-Fail’ (TBTF), it is meant to also revitalize market efficiencies. Repeal of risk-retention is a highly partisan provision and is likely to attract aggressive debate and may antagonize Democrats. If it remains a feature in CHOICE Act v2, there is the potential that it may be watered down (or washed out entirely) in a final bill.
2. Moving from Risk-Sensitive to Simple Capital Calculations
The Hoenig plan relies chiefly on the leverage ratio, which is meant to be a simple ratio of capital to assets. In contrast, the stress tests and risk-based capital (RBC) rely on internal capital models. The leverage ratio is useful in that it cuts through the complexities of a large bank’s balance sheet. Some regulators see this as a way to reduce the opportunity for regulatory capital arbitrage and/or the ability of banks to hide risk factors.
But the leverage ratio is also incomplete for both regulatory purposes and for the banks that need risk-sensitive tools to allocate capital internally to different business lines. For example, the leverage ratio treats U.S. Treasuries the same as subprime mortgages, which may be useful as a baseline measure, but hardly accomplishes the goal of ensuring that capital levels are appropriately sized to the risks on a bank’s balance sheet.
3. Does Hoenig Actually Mean 10%, or Is That the Starting Place
Hoenig mentions a 10% leverage ratio requirement as the minimum level for regulatory relief from various parts of the Dodd-Frank Act (DFA). The term sheet also mentions that the “requirements should be designed to ensure that all risks are generally captured”. The capital description goes on to further describe the risks that must be covered (pointing to a continued need for an RBC regime alongside the leverage ratio) and suggests that the supplemental leverage ratio (which could add several points to the capital ratio) might be useful in covering risks that the leverage ratio does not. Even at 10%, Compass Point estimates that banks would have to raise another $507 billion in capital, most of it by the largest banks.
4. What Is There to Like about the Trade-Off for Higher Capital Levels Under Hoenig’s Plan?
The main benefits for banks that meet the 10% (or more) leverage ratio, according to Hoenig’s plan are exemptions from:
· Basel liquidity requirements, including the Liquidity Coverage Ratio and the Net Stable Funding Ratio (in the proposed phase):
· Most of Section 165 of the Dodd-Frank Act, including stress tests (capital assessments (CCAR) and actual stress tests (DFAST)); and
· Replacement of Volcker with trader mandates.
Bear in mind that because the banks will still have to maintain RBC functions, the costs of compliance will be reduced, but perhaps not significantly. The main place that banks qualifying for the regulatory relief would receive is likely to be a reduction in regulatory risks, which translates into fines and the ripple effects banks deal with when regulators rebuke them in public.
5. 21st Century Glass-Steagall Resembles European Model
As described in the Hoenig plan, 21st Century Glass-Steagall is a kinder, gentler version of the original law, because it allows broker-dealer activities to be housed under the same roof as traditional banking activities. The new version attempts to neutralize the risks of trading and other activities with a virtual firewall between the two sets of businesses, which are effectively built from the separation of legal entities, governance and other controls. The Hoenig design also bears similarities to the ring-fencing requirements promulgated in Europe since the crisis. Though this design may exist in “real life” and it shares some similarities with the good-bank/bad-bank solutions applied to failing banks, ring-fencing has never been tested. No bank that was ring-fenced while healthy has failed and undergone a resolution, which could tell us whether this approach is effective in dealing with TBTF bank failures.
Underlying this new age Glass-Steagall is the clear decision that the Volcker rule did not solve enough of the resolvability puzzle for large banks. Indeed, Hoenig’s plan seems to discard Volcker and replace it with trader mandates, which would presumably be internal policies that carry little to no regulatory/compliance risks.
Preliminary Conclusions for Commercial Real Estate Businesses:
While the Administration and Congress are herding their cats, the commercial real estate sector can assume the following if some facsimile of the Hoenig plan is imposed on the banking sector:
1. Capital requirements will increase, but the internal allocations on a relative basis most likely will not; and
2. To the extent that regulatory/compliance risks were driving the retrenchment of capital available to trading desks, then the reversal away from Volcker may trigger a return to deeper and larger secondary markets; but
3. If instead the capital burden is the greater factor in reduced capacity on secondary desks, then the Hoenig plan may cause more disruption in those markets.
Trump’s nominee for Treasury Secretary, Steve Mnuchin, was questioned last week by Members of the Senate Finance Committee on how he will serve as Secretary of the Treasury if confirmed. (The Finance Committee, not the Banking Committee, will vote on the nomination). Below is CREFC’s analysis of how Mnuchin, if confirmed, will treat issues affecting commercial real estate (CRE) finance. We base our analysis on both Mnuchin’s testimony and written responses.
Volcker Rule 2.0: CREFC’s policy staff is inclined to believe, under a Mnuchin regime, that the Volcker Rule will be administratively softened in the years ahead. During testimony, Mnuchin said: “As Chair of FSOC I would plan to address the issue of the definition of the Volcker Rule to make sure that banks can provide the necessary liquidity for customer markets and address the issues in the Fed report.” Administrative reforms will probably mean a retool of the rule to more clearly define “prop trading” and facilitate greater liquidity as dealer inventories grow. This “bright line” referred to by Mnuchin could entail establishing metrics that would seek to delineate proprietary trading from market making.
Stepping Back from the RNC’s Position on Glass-Steagall: During his testimony Mnuchin repeated his willingness to consider a reprisal of Glass-Steagall. While a “Glass-Steagall 2.0” has no apparent pathway to becoming law, as Congressional republicans have so far been adamantly against such a reform, we would caution the market that any future headline risk from the financial services industry could change opinions in Washington.. On the campaign trail, then-candidate Trump seemed warm to the idea of a “21st Century Glass-Steagall”, but the issue has not received much attention from his advisors since. Breaking up the banks à la Glass-Steagall appears to run counter in philosophy to relaxation of the Volcker rule.
Like-Kind Exchanges and Tax Reform: In his written responses to questions from Committee Members, Mnuchin offered definitive, but targeted, support for certain like-kind exchanges: “I agree that farmers, ranchers, and small business should be able to use like-kind exchanges for real and personal property in order to operate efficiently, create jobs, and strengthen the US economy.” To be fair, the wording of his answer was mostly parroting the question’s language. Given this exchange and hearing from the chief tax writer in the House, we believe current odds favor little disruption of current like-kind exchange provisions (also referred to as 1031 exchanges) during the upcoming tax reform debate. Please see Tax section later in this bulletin.
Fannie and Freddie. The Government-Sponsored Enterprises (GSEs) – Fannie Mae and Freddie Mac – were discussed as part of three separate Q&A segments, including both of Sen. Warner’s (D-VA) rounds. In aggregate, Mr. Mnuchin made three broad points. First, he distanced himself from calls to “recap and release” the GSEs and stated his hope for a bipartisan solution. Second, he described the GSEs as “very important entities” and touched on their role in ensuring secondary-market liquidity. Third, in the context of GSE reform efforts, Mr. Mnuchin repeatedly stated his goals were to protect taxpayers, ensure access to housing-related capital, and work in a bipartisan manner. Our view is that Mr. Mnuchin’s comments left just enough for everyone in the housing policy conversation to find something they can praise and something they can condemn, but we do not believe the broader mortgage finance policy conversation has been meaningfully altered. It is clear that Mr. Mnuchin is likely to bring a renewed sense of urgency to the issue, but other issues will be prioritized in the near-term (e.g., tax reform). Accordingly, our view remains that comprehensive mortgage finance reform legislation meaning a bill that alters either the GSEs’charters or conservatorship -- only has ~30% likelihood of enactment in this Congress. We maintain, however, that the declining GSE capital buffers, the potential impact of tax reform on Fannie Mae’s and Freddie Mac’s deferred tax assets, and the upcoming change in personnel could compel targeted administrative policy shifts. Furthermore, Senator Crapo has kept GSE reform a priority. So regardless of whether a bill can be passed this year, we believe that Senate Banking is highly likely to take up the debate this Congress.
On Tuesday, January 24th, the Senate Banking Committee overwhelmingly approved Dr. Ben Carson for the post of Housing Secretary, clearing him by voice vote. No date has been set for the full Senate to give Carson an up or down vote, but CREFC expects an easy path to confirmation barring any late-breaking developments.
While Mr. Carson’s testimony primarily concentrated on single-family housing, he did state, in line with President Trump, that “Overly burdensome housing regulations are bad for everyone and are increasing income inequality. Research by Harvard professors found that by reducing the ability of people to move around within an economy and between different economies, strict land use regulations are reversing 100 years of income convergence across U.S. states.” We believe this deregulatory theme will also apply to multifamily housing as well, though no details have been provided as such by Mr. Carson.
Forbes-Tate Partners is CREFC’s outside counsel for monitoring legislation outside of and intersecting with CRE, Congressional Leadership, and the White House.
As you know, comprehensive tax reform is at the top of the agenda for the Trump Administration and Congressional Republicans. Specifically, enacting comprehensive tax reform has long been a priority for House Speaker Paul Ryan; we fully expect him to expend significant political capital in order to get a bill passed out of the House of Representatives prior to the August recess. In preparation for a push to overhaul the tax code, House Republicans under Ways and Means Committee Chairman Kevin Brady (R-TX) last June released a blueprint that outlines their overarching vision for reform. This document was meant to provide a framework for House Republicans to run on during their re-election campaigns and to subsequently provide a path forward for the Trump Administration.
Currently, the Administration and Congress are working to add further details to the blueprint and to craft legislative language codifying the principles contained in the document. The timing for the release of a more concrete plan remains uncertain, but we expect to see a discussion draft or legislative language in the later 1st or early 2nd quarter. As expected, the process is fluid, with much of today’s corporate tax debate focused on new policies, including border adjustability (the so-called “BAT”), interest deductibility, and proportional expensing.
House Republicans are further along than their Senate counterparts, but we fully expect the Senate to turn its focus to tax reform following the completion of work on items including confirmation of Administration nominees, efforts to overturn Obama-era regulations through the Congressional Review Act, and legislation to repeal and replace the Affordable Care Act. We will continue to provide you with updates as the process progresses. Please see the next story to understand the implications for commercial real estate as it relates to tax reform.
As described above, comprehensive tax reform is at the top of the agenda for the Trump Administration and Congressional Republicans. House Republicans, under Ways and Means Committee Chairman Kevin Brady (R-TX), last June released a blueprint that outlines their overarching vision for reform. The plan is certainly unconventional – it takes a holistic view of revenue capture and gores many sacred cows in the process. The Senate has not developed a bill, as tax reform legislation must begin in the House.
The blueprint proposes significant changes for commercial real estate. Below are high-level descriptions of the reforms being considered:
Reductions in Marginal Rates: The plan would reduce the corporate tax rate to 20% and reduce the top rate on pass-throughs, such as partnerships and LLCs, to 25%. In addition, the blueprint would lower the top individual rate to 33% and allow individuals to exclude 50% of qualified investment income. Accordingly, long-term capital gains and dividend income would be subject to a top rate of 16.5%. To provide for these massive rate reductions, the Chairman proposes deemed repatriation of foreign earnings and a border adjustment tax (BAT) regime (see below) that together have the potential to raise over $1 trillion.
International Tax: In the international tax area, the blueprint proposes a destination-based system under which income earned outside the United States would generally not be subject to US tax. As a transition (i.e., a one-time “revenue raiser”), previously accumulated foreign earnings (currently estimated at over $2 trillion) would be subject to tax (in other words, deemed to be repatriated) at a lower tax rate.
The blueprint establishes the above-mentioned BAT, under which exports from the United States would not be subject to US tax – regardless of where products and services are produced, and conversely, products and services that are imported into the United States are subject to US tax. Proponents assert that this proposal could remove incentives to transfer businesses outside the United States as well as attract foreign investment into the United States. Brady has been quoted as saying, “This is a very simple policy. Is your product or service consumed in the U.S.? ... Once businesses understand it's not a VAT, and you don't have to track it transaction by transaction ... At the end of the year, a business adds up its export sales and doesn't count it as income. At the end of the year, it adds up its import costs and doesn't count them as expenses. That's the border adjustable tax. It is that simple.”
Full Immediate Expensing: The blueprint would allow an immediate deduction for 100% of the investment in all property except land, which would eliminate the current depreciation regime. For the purchase of a building, for example, the buyer could immediately write-off the full expense in the first year instead of taking depreciation over several years. If the full expensing creates a net operating loss (NOL), the NOLs can be carried forward indefinitely, though the deduction is limited to 90% of net taxable income.
Interest Income Deduction: Another feature that may be of significant concern to the commercial real estate industry is the interest limitation proposal. The blueprint would limit interest deductions to the amount of interest income, which could be detrimental to industries like real estate that rely heavily on leverage. In most cases, without significant interest income, the provision would essentially result in a denial of the interest deduction.
Currently, the blueprint provides little detail on how it would treat existing debt, however the blueprint notes generally that there will need to be transition rules.
Other Real Estate-Related Issues Not Specified in the Blueprint
Like-Kind Exchanges: Section 1031 allows the tax-free exchange of similar assets, such as real estate, and is commonly used in the commercial real estate industry. While the blueprint does not mention repeal of or modification to section 1031 specifically, like the mortgage interest deduction, it is frequently cited as another provision that might be eliminated or modified to raise revenue for other changes. For example, former House Ways & Means Chairman Camp proposed to eliminate the provision, while President Obama’s budget proposed certain limitations. It is possible that Ways and Means will consider section 1031 as a “special-interest” provision that should be eliminated or modified. Thus, the treatment of like-kind exchanges should also be watched closely. Note that Treasury Secretary Nominee Mnuchin expressed support for such exchanges during his confirmation hearing (see the above story).
REITs and MLPs: Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs) are also not mentioned in the blueprint, and thus, the tax-preferred status of these entities is uncertain. Other features of the blueprint might have an impact on these structures, such as the immediate deduction for investments in all property except land, which would be a tremendous benefit for real estate, including that held through REITs and MLPs.
REMICs: Real Estate Mortgage Investment Conduits (REMICs) are a critical tax structure for Commercial Mortgage-Backed Securities (CMBS). They are similarly not mentioned in the blueprint, and there has been little to no discussion about any proposed changes to their status or structure.
Carried Interest: Taxing carried interest at ordinary income rates is another proposal that, while not specifically mentioned in the blueprint, is raised frequently as a potential revenue source. Changes to the carried interest rules have been proposed on Capitol Hill and the Administration, and during the campaign; both Hillary Clinton and Donald Trump supported changes. Real estate partnerships frequently utilize carried interest structures (generally called a “promote” in the real estate context) and even though the political rhetoric is generally targeted at private equity and hedge fund managers, the high-profile debate over this provision makes it likely that it will be raised in future tax reform discussions, with potential impact on real estate.
In one of the Trump
Administration’s first official acts on January 20, executive departments and
agencies were asked to freeze review and final publication of pending
regulations. You can see the memo here. While the move is headline-grabbing, it
should not be viewed as controversial; the Obama Administration issued a
similar freeze request in 2009, available here.
move essentially asks that President Trump’s appointees be given the
opportunity to review any regulations in the pipeline, which the new leadership
could subsequently withdraw, revise, or implement without change. In
effect, this a temporary measure to pause regulations while the new
administration is setting up shop.
action is limited in scope primarily because it does not apply to the
regulators that oversee commercial real estate finance. Specifically, Trump’s
recent freeze does not apply to ‘independent agencies’, which include
the FDIC, Fed, OCC, SEC, CFTC, and CFPB. Independent agencies generally
differ from executive or cabinet agencies (like Treasury, Homeland Security,
Labor, etc.) in that their leadership cannot be fired “at will” by the President.
Some independent agencies are also insulated from annual congressional
they have the ability to self-fund through means such as assessments on
industry or transactional fee structures.
agencies may choose to put some regulations on hold, but they would not face
any formal repercussions if they chose to move forward with rulemakings.
For a deeper background on the applicability of the memo to independent
agencies, see Executive Order 12866, which is referenced in the
White House memo.
Pathway to Regulatory Reform
most of the relevant CRE finance rules are promulgated by the above-listed independent
agencies, CREFC staff do not expect this action alone to divert rulemaking
around any of the major items in the regulatory pipeline, such as the
risk-based capital changes awaiting adoption in March by the Basel Committee on
Banking Supervision and the Net Stable Funding Ratio, scheduled to be adopted
by the FDIC, Fed and OCC in 1H 2017.
pending leadership changes at many of the agencies could lead to delays
or withdrawal of pending rules. In limited cases, leadership change
at an agency could also result in revisions to standing rules. As of this
writing, there is little known about pending leadership changes or any specific
information to suggest that the pending rules will not be adopted.
narrow area of CRE finance applicability relates to some foreign capital
inflows. The regulatory freeze does apply to a proposed rule relating to the EB-5 visa program,
which grants foreign investors eligibility for permanent residence status if
they make a qualifying investment in a commercial enterprise in the U.S.
current rules, the EB-5 visas are available to immigrants who invest $1 million
in a commercial project that will create or preserve at least 10 jobs in the
U.S. The threshold amount is reduced to $500,000 if the applicants choose to
invest in a high-unemployment area. An investment can be made directly
into the business or through an approved “regional center”, which is a
third-party vehicle that handles the job creation aspects.
January 13, the Department of Homeland Security proposed a new rule that would dramatically increase required
EB-5 investment thresholds. Under the proposed rule (covered by the Trump
freeze memo) the standard investment thresholds would rise to $1.8 million
generally and $1.35 million in high unemployment areas. The thresholds in
the proposed rule are higher than levels Congress currently is contemplating as
it works to reauthorize a portion of the program, which lapses on April 28,
the regulatory freeze, the Trump administration and new Homeland Security
Secretary John Kelly will now take the lead in determining the fate of the
rule, but the industry likely will have options to provide feedback. The
proposal currently is open for comment until April 11, 2017. Moreover,
Congress’s reauthorization efforts will provide a forum to examine parameters
of the EB-5 program.
More to Come
In 2015, the CREFC team published a study with Dr. Sam
Chandan, Associate Dean of the Schack Institute of Real Estate at NYU School of
Professional Studies, that summarized our and others’ regulatory impact on
multifamily and commercial real estate lending analyses. That model, which
estimated the inflection point at which borrowing costs become disruptive, can
be used for all types of rate shocks. Based on CMBS loan data, we estimated
that a 100-basis-point movement in rates was the point at which borrowers might
conclude that funding costs did not tie out with deal economics. Many variables
affect the analysis, but this past week’s second rate hike in the U.S since
2008 suggests it is time to revisit the estimated headroom in the CRE market,
or stated another way, the marginal borrowing cost increases borrowers are
willing to absorb before such increases trigger a dislocation in the market
such that borrowers are unable to refinance maturing loans.
Taken together, the December 14,
2016 25-basis point rate hike and the approximately 25-basis points of
regulatory-driven increase since the CREFC study leave about 50 basis points of
headroom. Admittedly, this is a blunt model in that it assumes that the rate
increases affect all loans equally and that all other factors remain
When you consider the costs of the capital and liquidity
regulations that are coming into place in 2018 (Net stable Funding Ratio (NSFR),
Fundamental Review of the Trading Book (FRTB), and others), in addition to the
potential for further rate increases, it may seem tight. Together, we estimate that the NSFR and the
FRTB will add roughly 10 basis points of costs to high-quality loans and bonds.
The NSFR is often referred to as a new “binding constraint” (the regulatory requirement that is most
onerous), alongside risk-based capital, the leverage ratio and stress tests. As
to the FRTB, the trade associations (GFMA, IIF and ISDA) that led the industry
comment letters submitted throughout the several year consultation cycle (but
most recently on January
14, 2016), estimated that the FRTB would require banks to hold an average
of 2.2 times the amount of capital currently being held against all
securitization asset classes. A senior tranche with a 15% risk weight today
could have a 33% risk weight in 2018. The FRTB and other new requirements will reduce total headroom to approximately 40 basis
points, which allows for less than two rate hikes of 25-basis points.
Considering that the normalized benchmark Fed Funds rate is
considered to be 3.00%, according to certain analyses, our headroom appears to
be relatively low. Jeffrey Lacker, President of the Federal Reserve Bank of
Richmond, speculated last week that there might be three or more rate hikes in
2017. (Lacker will be a voting member of the FOMC next year, but he will be an
alternate.) At the same time, we know that rate increases have been largely
offset by inflows of capital into the U.S., and that at least some of that
capital is put to work in the commercial real estate markets.
If foreign capital is one of the biggest offsetting factors
to potential borrowing cost shocks, it would be wise to monitor risk factors to
those flows. While this is not a sufficient forum to review all the drivers of
fund flows, it is critical to note that the same monetary policy moves that
make USD-denominated assets more attractive, can also make foreign currencies
While the U.S. CRE markets have a lot going for them and
they are clearly able to absorb more disruption, there is both a theoretical
and an actual limit to the shocks that can be adjusted to in a relatively
seamless manner. In 2017, the CREFC team will be working to minimize further
regulatory impact, and we welcome your input and support. For engagement,
please contact me, David McCarthy or Marty Schuh.