The four-page multi-agency communique likely triggered immediate heartburn among bank credit officers. The anxiety for CRE lenders will be delayed as they await memos from their credit departments effectuating the government decree. Borrowers will get the message during 2016 in the form of less friendly term sheets.
The missive begins with positive “recent supervisory findings” – the growth in CRE lending, rising property values, low capitalization rates, and high quality loan portfolios with “reassuring trends in asset-quality metrics.” Yet, just when you thought the joint statement was a pat on the back to one of the U.S.’s most underappreciated and overregulated private industries, the watchdogs resorted to generally accepted governmental contrarian logic. The agencies collaboratively declare that now is the time for all banks to tighten up the credit underwriting process and refocus on a page-long list of “Interagency Regulations and Guidance” dealing with “sound risk management.”
The federal apprehension emanates from what the agencies sense are “increased competitive pressures, rising CRE concentrations in banks, and an easing of CRE underwriting standards.” Specific concerns noted in the memo include:
» Less restrictive loan covenants
» Extended maturities
» Longer interest-only periods
» Limited guarantor requirements
» Exceptions to existing credit policies
» Insufficient assessment of market conditions
» CRE concentration
The first four items are term sheet provisions that command any borrower’s immediate attention. Interestingly, those four factors are significantly influenced by a robust Permanent Loan market, which utilizes a securitized product largely outside these regulators’ dominion. In the permanent loan market – where many CRE bank loans are refinanced after a project’s stabilization – it is common to see fewer covenants, extended maturities, longer interest-only terms and carve-out guaranties. (See COMMERCIAL FINANCE 701: Permanent loans & other oxymora, April 30, 2015).
CRE concentration is, admittedly, an appropriate concern. SNL Financial reported in a December 30, 2015 article that at the end of 3Q ‘15, 474 banks exceeded recommended concentration levels (loans compared to risk based capital), up from 389 banks at the end of 3Q ‘14 but down from 556 banks at 3Q ‘11.
Banks targeted for special examination include those with recent growth in CRE loan portfolios or “lending strategy plans” contemplating CRE loan growth. Miscreants who run afoul of the woolly parameters may be asked to submit plans to (1) “identify, measure, monitor, and manage CRE concentrations,” (2) “reduce risk tolerances,” and/or (3) “raise additional capital” – all federalese for expensive and toilsome enforcement actions.
Absent from the agencies’ statement is any suggestion of actual violations of regulations. This funereal diktat speaks to performing loans that otherwise satisfy all specific lending requirements – including, as examples, LTV ratios, FIRREA appraisals, equity injections, title insurance, and credit committee approval. Also unmentioned are Basel III and HVCRE – existing burdensome federal requirements, most of which became effective January 1, 2015, and imposed various restrictions and additional capital requirements on CRE lending. (See COMMERCIAL FINANCE 701: Basel III, HVCRE & real estate loans, May 14, 2015).
In summary, CRE lending will be tougher for both the borrower and the lender in 2016.
Some analysts may point to the Great Recession of 2007 and applaud this anticipated crackdown on CRE lending. As an example, Dr. Mark Zandi – the chief economist of Moody’s Analytics and a perennial Congressional expert witness – quickly declared the new initiative “entirely appropriate,” noting that CRE lending “has done the banking system in more than once over the decades.” This past October, Dr. Zandi praised the “messy … massive, and unprecedented responses” of the federal government to end the Great Recession, crediting such actions with “preventing another Great Depression.”
Without questioning the propriety of prior federal actions, we challenge any premise that some limited, focused regulation supports unlimited regulations or that banks post-2015 should be treated like banks pre-2007.
The regulatory playing field has changed dramatically. The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 inaugurated an unprecedented era of federal control. In addition to enhanced examination and related compliance costs, CRE lenders have been subjected to “stress tests,” the Basels (I, II and III), and HVCRE requirements.
The Economist published a 2012 article entitled “Over-regulated America” with the subtitle “The home of laissez-faire is being suffocated by excessive and badly written regulation.” The author noted the Dodd–Frank legislation ran “848 pages … 23 times longer than Glass-Steagall, the reform that followed the Wall Street crash of 1929.” Also in 2012, the American Bankers Association counted 7,224 pages of Dodd-Frank-related regulations. That was then. The ABA’s estimate as of November 11, 2015 is 22,799 pages of final regulations, proposed regulations, and guidelines. The U.S. House of Representatives’ Financial Services Committee estimates Dodd-Frank will take $27 billion out of the economy annually and businesses will spend 24 million hours each year complying with Dodd-Frank’s current regulations.
As for the tautening of CRE lending in 2016, the blame will get misdirected. Borrowers will fault the loan officers, loan officers will point to credit departments, and credit departments will take it on the chin – as will banks’ CRE profit margins. Blaming the federal government rarely proves productive.
In articles past, we have favorably cited the anti-big government president Ronald Reagan. In a bipartisan spirit, we’ll now quote from one of this nation’s most popular Democratic presidents: “If it is in the public interest to maintain an industry, it is clearly not in the public interest by the impact of regulatory authority to destroy its otherwise viable way of life.” JFK.
» Ben Williams and Molly Jeffcoat Moody are attorneys engaged in an active commercial law practice at Watkins & Eager PLLC. Ben and Molly are both recognized by Chambers USA and Best Lawyers in America. Ben was selected as Best Lawyer’s 2016 Project Finance Lawyer of the Year in Jackson, Mississippi. Additional information is available at www.watkinseager.com.