Regulations at Just the Wrong Moment



The commercial real estate lending market is about to get more complicated, as the new capital surcharge regulations on the country’s largest banks started to be phased in as of Jan. 1. These regulations, which require big banks like J.P. Morgan Chase, Citigroup (C) and Bank of America (BAC) Merrill Lynch to hold varying amounts of additional capital as a buffer, are meant to add a measure of economic stability to the economy. But they may do the opposite, and may even force lending away from traditional players to others that are less regulated. How will this affect both borrowers and lenders?

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To answer that question, it’s important to look at the bigger picture: the unfortunately timed interplay of four factors in the U.S. commercial real estate market right now. There’s the capital surcharge regulation, which goes into full effect in 2019. Meanwhile, there’s also a rising interest-rate environment (the December hike is widely expected to be the first of several) and the U.S. Securities and Exchange Commission’s forthcoming risk-retention rules constraining CMBS markets. All affect the cost or availability of capital, just as the refi wave for CMBS deals made in 2006–07 will mature in the coming year or two.

The overlap is taking place at exactly the wrong moment. The bank regulations were formulated in response to the recession, but the implementation period doesn’t match the economic cycle—whether that is seven years, as popularly thought, or closer to five years, as the National Bureau of Economic Research has found.

Instead, capital could become more costly, scarce or both. In the worst case, the supply of capital could go down, or the price of money could go up substantially due to these factors. This could make it harder and more expensive for borrowers to access capital—just as they need it most.

The capital surcharge is calculated to reflect the overall risk posed by eight of the biggest U.S. banks, led by J.P. Morgan. As of the time the surcharge was announced in July, J.P. Morgan had the highest surcharge, 4.5 percent, and a $12.5 billion capital shortfall. (That picture looks to be changing in the wake of its recent diet, but more on that below.) The surcharge rates get progressively smaller for the other seven: Citigroup, Bank of America, Goldman Sachs (GS), Morgan Stanley (MS), Wells Fargo (WFC), State Street and, lastly, Bank of New York Mellon, with a 1 percent surcharge.

Though this increases the cost of business for the big banks, that doesn’t mean there won’t be any winners here. Small banks; non-U.S. banks like Bank of China (BACHF) and Deutsche Bank (DB); and non-bank lenders, such as hedge funds, private equity funds like Blackstone (BX) Group and Carlyle, and some pension funds and insurance companies, stand to benefit from the increased regulation of their competitors.

The small banks and non-bank lenders that remain unhindered by additional regulation don’t need to keep the same quantity of reserves on hand, thus giving them a boost when competing for loans with big banks that may now want to reduce their lending exposure or raise their lending rates.

But big non-bank lenders like AIG, GE Capital, Prudential (PRU) Mortgage Capital Company and MetLife—all classified as systemically important financial institutions, or SIFIs, which are subject to stricter oversight and regulation—are in more or less the same boat as the big banks.

As for borrowers, they may find it harder to access financing, but there will ultimately still be lenders out there. What exactly those lenders will look like may change, however. In fact, the shape-shifting has already begun.

Among banks, J.P. Morgan Chase added to its loan-loss reserves in January, for the first time since late 2009, and has cut many of its capital-intensive assets, which could push its capital buffer requirement down to 3.5 percent, according to recent reports from Dow Jones and The New York Times. Even so, J.P. Morgan Chase has been involved in big CRE loans in 2015, such as a $175 million loan (in conjunction with Citigroup Global Markets) for the Great Wolf Lodge in Concord, N.C., and a $1.035 billion consolidation and modification loan, in conjunction with Morgan Stanley and Citibank, for the News Corp. building at 1211 Avenue of the Americas, according to CrediFi, the real estate debt data company I head.

There are even bigger changes afoot among non-bank SIFIs, some of which are scaling down in a bid to become less systemically important.

Take GE, which sold off most of its GE Capital Real Estate assets to Blackstone and Wells Fargo for $23 billion, in a deal announced in April. Yet while GE is pulling out of the real estate business and reportedly plans to apply in Q1 of this year to remove its SIFI designation, MetLife, the largest life insurer in the U.S., is digging in its heels.

MetLife, which is appealing its SIFI designation, said in January that it plans to separate its retail business in a spin-off, sale or public offering, explicitly citing the risk of increased capital requirements as a factor in the decision. A week later, the life insurance giant announced that it had formed a real estate investment venture with New York State Common Retirement Fund, the third-largest public pension fund in the U.S., and that the initial investment portfolio is valued at more than $1.4 billion.

At this rate, it’s not quite clear what exactly the big players in the U.S. economy and, more specifically, the commercial real estate market, will look like by the time the bank regulations fully go into effect in three years. However it plays out, though, the perfect storm of stricter governmental regulations, a rising interest rate environment and the capital-demanding maturity wall means that the capital surcharge regulations could ultimately shake up the lending market rather than stabilize it.