By Kevan McCormack

So maybe you have heard about this thing called Basel III, and maybe you haven’t.  For those of you wondering what Basel III is, keep reading.

Basel-III-capitalBasel I was originally established in 1988 by the Basel Committee on Banking Supervision (“BCBS”) in Basel, Switzerland.  G-10 countries enforced this accord as law beginning in 1992.  Basel II was agreed to in June 2004 but has since been essentially replaced by Basel III.  Basel III, agreed to on September 12, 2010, is a voluntary, global regulatory standard on bank capital adequacystress testing, and market liquidity risk.  As an expansion of the Basel I and Basel II deliberations, Basel III was formed as a direct response to the financial crisis of 2008.  Basel III’s main focus is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage, thus minimizing the risks associated with potential “bank runs” while helping the global financial market become more resilient to future system shocks.  Both of these goals do two things: they reduce the amount of money available to be loaned and create an upward pressure on the cost of borrowing.

These new regulations can have a significant impact for small and medium businesses’ access to capital, but as it directly relates to commercial real estate, there a couple of important items for real estate investors and developers to keep in mind as these regulations become fully implemented in our capital markets over the next few years.  Commercial real estate loans are categorized as High Volatility Commercial Real Estate (“HVCRE”) for all development, acquisition, and construction commercial real estate loans except:

i.            1-4 family residential loans; and

ii.            commercial real estate loans that:

  1. meet applicable regulatory LTV regulations;
  2. have at least 15% cash equity based on “as-complete value”;
  3. have the cash equity required to remain in the deal until loan converts to permanent loan, is sold, or is retired.

Banks classifying commercial real estate loans as HVCRE will have to change their risk-weighting for those loans from its current level of 100% to 150%.  This will impact banks’ Solvency Ratio and potentially reduce their overall lending capacity, leading to credit rationing amongst bank clients.  The end result is a tightening of market liquidity and, ultimately, reducing GDP potential.  A recent OECD study estimated that these regulations could be responsible for a decrease in GDP of 0.05% to 0.15% annually.

While these standards will be phased in by many countries over varying degrees of time, for the U.S. banking system, Basel III will not be fully implemented until 2019; however, there are some pretty significant standards taking effect on January 1, 2015.  Keep this in mind when you visit the capital markets again next year and wonder why there may be less willingness to push leverage for your new development.  We also expect there to be more importance placed on deriving a proper “as-complete value” where achieving a higher value may not be in the Borrower’s best interest.

For the past twenty-three years, Metropolitan Capital Advisors has completed over $5.5 billion of loan placements with banks.  MCA understands the intricacies of the bank debt markets and is well-equipped to advise our clients on the best available capital offered by the banking community.  To further discuss your CRE capital requirements, please contact our Senior Directors, or visit our website at www.metcapital.com