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NATIONAL ASSOCIATION OF REALTORS
October 31, 2003
Office of the Comptroller of the Currency
250 E Street, SW
Public Information Room Mailstop 1-5
Washington, DC 20219
Comments Re: Docket No. 03-14, RIN Number 1557-AC48
Ms. Jennifer J. Johnson
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551
Comments Re: Docket No. R-1154
Robert E. Feldman
Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Comments Re: RIN 3064-AC73
Regulation Comments
Chief Counsel's Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Comments Re: No. 2003-27, RIN 1550-AB56
To Whom It May Concern:
The NATIONAL ASSOCIATION OF REALTORS (NAR), representing over 950,000
real estate practitioners, would like to submit the following comments
on the Advanced Notice of Proposed Rule Making governing the Risk-Based
Capital Guidelines; Implementation of the New Basel Capital Accord. The
NATIONAL ASSOCIATION OF REALTORS®, The Voice for Real Estate®, is the
world's largest professional trade association. NAR is composed
of REALTORS® who are involved in residential and commercial real estate
as brokers, salespeople, property managers, appraisers, counselors,
investors, developers and others engaged in all aspects of the real
estate industry.
Members belong to one or more of some 1,700 local associations/boards
and 54 state and territory associations of REALTORS®. Additionally,
thousands of REALTORS® are members of NAR's many institutes, societies
and councils, designed to enhance their expertise and network with other
professionals globally. These include the Certified Commercial
Investment Member (CCIM), the Institute of Real Estate Management (IREM),
the REALTORS® Land Institute (RLI), the Council of Real Estate Brokerage
Managers (CRB), the Council of Residential Specialists (CRS), the Real
Estate Buyer's Agent Council (REBAC), the Society of Industrial and
Office REALTORS® (SIOR), the Counselors of Real Estate (CRE) and the
Women's Council of REALTORS® (WCR).
As international developments have played an increasing role in how
and where capital is invested throughout the world, NAR has expanded
global real estate market opportunities for its commercial and
residential members. Since NAR started its international operations
program in the early 1950s, the Association has built a network of cooperative
agreements with real estate associations around the world, and has
actively expanded and developed this network. NAR has promoted
international real estate education, development of technical standards
and technical information exchange, and international real estate
practice in a number of areas, including commercial outreach activity
and development of an international real estate consortium.
NAR took a leadership role in helping organize the International
Consortium of Real Estate Associations (ICREA) in 2001. ICREA's mission
is to assist constituent members to efficiently serve their customers
and clients through the development and maintenance of international
business standards, products and services. Objectives of the consortium
include technical standards for data transfer, an international referral
system and advocacy, including promoting best practices worldwide.
New Basel Capital Accord
NAR supports the overall goal of the new Accord, which is to create
regulatory capital standards that are more aligned with the underlying
economic risks that a bank will incur. The new Accord will permit
qualifying institutions to calculate their minimum risk-based capital
requirements by using their own internal risk estimates, which we
believe will promote strong risk management. The Accord is intended to
provide an incentive for banks, in the form of lower capital
requirements, to employ sophisticated modeling techniques, loss
mitigation tracking tools and risk modeling tools. NAR believes that the
objectives of the new Accord are important to ensure consistency and
competitiveness among internationally active and domestic banks,
particularly those that engage in real estate lending.
We believe, however, that the new Accord poses some adverse
consequences for residential and commercial lending. Even though the
capital charges on certain types of commercial real estate loans provide
for optional treatments based on national discretion, the fact that real
estate lending is treated differently overall in the new Accord will
lead to a loss of credit opportunities in that sector. Real estate is vital to the U.S. economy because the housing
sector directly accounts for about 15 percent of the total production
and an additional 6 percent of economic activity is derived from
indirect housing-related expenses.
The new Accord consists of three pillars, the most important of which
is Pillar I. This Pillar consists of minimum capital requirements, which
are the rules that a bank uses to calculate its capital ratios. The
Pillar I capital requirement includes a credit risk charge that is
measured by an Internal Ratings-Based Approach (IRB).
Credit Risks Under the Internal Ratings-Based Approach (IRB)
The IRB approach allows a bank to use sophisticated internal credit
risk rating models and systems to measure capital adequacy. The IRB
approach includes a foundation internal ratings based approach version
and an advanced internal ratings based approach version. The foundation
version means a bank has a system in place to accurately estimate for
each credit exposure the probability that the borrower will default.
Under the advanced approach, besides estimating the probability of
default, a bank would have to estimate the likely size of the financial
loss in the event of a default and an estimate of what the total amount
borrowed would be at the point a likely default would occur.
Under the IRB approach, banks would have to classify their exposures
into broad classes of assets. These classes include sovereign, bank,
retail, equity and corporate. Within the corporate asset class there are
five subclasses of specialized lending including project finance, object
finance, commodities finance, income producting real estate, and
high-volatility commercial real estate. Income producing real estate
refers to a method of providing funding to real estate such as
multifamily buildings where the prospects for repayment of the loan
depends on the rental payments coming in from the tenants or the sale of
the building. High-volatility commercial real estate lending is the type
of lending that could experience higher loss rate volatility (i.e.,
higher asset correlation) compared to other kinds of specialized
lending.
Real estate lending is divided into income producing real estate and
high- volatility commercial real estate categories. The risk weight for
both of these categories can be calculated under the formula for the
corporate asset risk class. If a bank qualifies to use the IRB approach
then it can use the corporate asset risk class formula to determine the
risk weights for income producing real estate and high-volatility
commercial real estate. However, for high-volatility commercial real
estate, banks will also have to apply a substitute asset correlation
formula in lieu of the asset correlation function currently assigned to
the corporate risk class formula. The reason for the substitute asset
correlation formula is the belief that high-volatility commercial real
estate loans tend to default at the same time, which necessitates higher
capital requirements.
Only residential and commercial construction loans are included as
high-volatility commercial real estate under the corporate asset
exposures. These are loans where the source of repayment on the loan is
dependent on the future sale of the property or cash flows from unknown
sources. In other words, a construction loan on a non pre-sold home
would have the same asset correlation as a loan to build a large
commercial development whose future tenants are unknown. NAR believes
that this will cause banks not to provide acquisition, development and
construction loans because these loans will have the same capital
expense as those associated with more risky lending activities.
NAR contends that improvements in underwriting such as requiring more
borrower equity, better appraisal procedures and improved credit scoring
techniques have made commercial real estate lending less volatile, as
demonstrated by the industry's reduced loan loss experience over the
last ten years or so. Also, through securitization vehicles like
commercial mortgage backed securities (CMBS), real estate's role in the
global markets has increased which has led to better transparency and
discipline, greater liquidity and a closer examination of commercial
lending activity worldwide. NAR believes that all commercial real estate
should be categorized as income producing and the high-volatility
commercial real estate category should be eliminated.
Banks that fail to qualify to use the MB approach will have to use
the preset minimum numerical capital ratios to determine the risk
weights for income producing real estate and high-volatility commercial
real estate. As a result, the specific risk weights could range from 75%
to 625% for income producing real estate and 100% to 625% for
high-volatility commercial real estate. In other words, if a bank cannot
use the IRB approach then it will incur higher capital charges for
income producing real estate and high-volatility commercial real estate.
As we previously indicated, these risk weights seem to be arbitrarily
high and not reflective of the advancements made in lending to the
commercial real estate sector.
Competitive & Cost Disadvantages for Smaller Banks and Inconsistent
Worldwide Enforcement
The new Basel Capital Accord will give some degree of regulatory
capital relief to a limited number of banks that qualify, in exchange
for investing in systems and infrastructure intended to improve risk
management. NAR is concerned that this will enable only the largest
banks that can invest in sophisticated capital allocation models, to
effectively operate with a lower capital ratio than smaller banks. These
banks will be able to grow and compete more aggressively for both assets
and liabilities to the disadvantage of smaller banks.
Small banks do not have the resources to implement the complex
internal risk weighting models that the new Accord requires. The
estimates range from $50 million to $200 million per bank to implement
the procedures required under the new Accord to evaluate and control
risk exposures. The costs associated with learning a new regulatory
system, installing new software and retraining staff will be prohibitive
to small banks. Small banks could become acquisition targets of banks
that qualify under the new Accord, which could result in further
consolidation of the industry. NAR believes that maintaining competitive
equality for smaller banks is important to serving smaller markets,
especially rural communities.
Finally, NAR is concerned that foreign banks will have a competitive
advantage because the prescriptive capital rules could be haphazardly
enforced outside the United States while being strictly enforced here.
Similarly, it is foreseeable that there will be great difficulties in
applying a complex set of rules equally across a wide array of banking
systems throughout the world. In this regard, it seems the complexities
of the new Accord will work against the goals of the original Accord.
Conclusion
NAR is concerned that under the new Basel Capital Accord financial
institutions will divert their resources away from real estate lending
and make loans to those sectors that do not require as much capital. If
the new Accord is enacted as currently envisioned, banks whose portfolio
is now geared toward real estate lending would refocus their lending
strategies away from real estate and towards investments requiring lower
capital charges.
NAR appreciates the opportunity to comment on the Advanced Notice of
Proposed Rule Making governing the Risk-Based Capital Guidelines;
Implementation of the New Basel Capital Accord. If you have any
questions please contact Peter Morgan at 202-383-1233 or pmorgan@realtors.org.
Respectfully Submitted,
David Lereah
Senior Vice President & Chief Economist
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