Last month, three Federal banking agencies–the Federal Reserve Board, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency–re-proposed capital rules to implement the 2017 Basel III reforms and adjusting capital surcharges for large, complex U.S. banks.
These agencies also suggested revising the standardized capital approach for most banks. With related stress-testing changes, banks can expect a moderate reduction in required capital holdings, according to Debevoise & Plimpton.
Analysts noted that this reduction could free up bank resources for lending and other activities. A recent Deutsche Bank securitization outlook report anticipates that the Basel III recalibration will reduce CRE risk weights to 95% from 100%.
The new proposal allows more granular distinctions based on the actual risk weight.
Notably, the minimum risk weight for senior positions will decrease from 20% to 15%. The proposal is expected to unlock around $100 billion in additional bank lending capacity and reignite demand for senior securitized products.
"The phrase people like to use is more 'risk sensitive,' meaning lower risk assets get a lower risk weight, and higher risk assets get a higher risk weight," said Chen Xu, Counsel at Debevoise. "In today's standardized approach, all non-defaulting assets are lumped in the same bucket. The new proposal allows more granular distinctions based on the actual risk weight."
Xu added that the formula reflects economic reality by linking a securitization's risk weight to the quality of its underlying assets. If there are high-risk or delinquent assets, risk weights rise; if the securitization is backed by strong-performing assets, risk weights fall. Both the current and proposed formulas do this.
According to Darrell Wheeler, senior vice president and head of CMBS Research at Moody's Ratings, risk weights differ significantly by institution type, with Tier 1 and Tier 2 banks being assessed based upon loan-to-value (LTV). For loans leveraged under 60% LTV, the risk weight is 70%; for those under 80% LTV, Tier 1 and Tier 2 banks receive a 90% risk weight—both improvements over the previous 100%. Other banks generally see the weighting drop to 95%, still an improvement. But, for Tier 1 and 2 banks with loans above 80% LTV, the risk weighting increases to 110%, which is less favorable than before.
Wheeler, however, noted that banks with loans already identified as 80% LTV may have already addressed or mitigated these risks.
A boost flagging CMBS demand
Deutsche Bank researchers also noted that securitized bond holdings have fallen since their 2022 peak, but the latest Basel III capital proposals should increase bank demand for triple-A bonds. Analysts added that bank demand for single-asset, single-borrower CMBS may not be as strong, since the Securitization-Standard Approach formula is quite punitive for delinquencies. Bank capital rises by multiples if a loan becomes delinquent, Deutsche said.
Debevoise's Xu said that one of the features of the current approach is that there's a floor on how low a bank's risk weight can go as a matter of supervisory safety net, which is 20%.
"The proposal would set the floor at 15%, meaning that banks holding the most senior position in any securitization, instead of 20, would go to 15, and that's clearly better," Xu said.
The drop to 15% minimum risk weight is "going to become a theme only in the senior class of the securitizations. In the junior classes, there will be different rules depending on the impairment and other factors. For banks, it doesn't really matter," Wheeler said.
He clarified that, in CMBS, most banks buy only agency-guaranteed senior classes. Some banks might be a bit more adventurous and have purchased five-year or first-pay CMBS, but those may also be senior classes.
"Banks rarely play in the junior subordinate CMBS pieces, so the tougher treatment there shouldn't make much difference for them. A capital relief from 20 to 15 may change their appetite for CMBS or improve it, but they are not a long-term segment of the CMBS investor base, so an improvement might not affect overall demand for CMBS or its pricing," Wheeler said.
Surprise Element
Under the proposal, the agencies flagged a change in the definition of securitization, which they characterized as a technical change or definitional fix. However, Xu said that some banks think it goes beyond that and that it probably needs to be addressed in the proposal's comment process.
"The agencies are clarifying that if a securitization has a pool-wide or parent guarantee, it can no longer fall under the securitization framework, but should be treated as a general credit risk. However, people are pointing out that that's not really an economic reality."
The agencies' intent is that when a parent or sponsor guarantees a securitization, it is the parent—not the assets—that backs the exposure.
"There's some conceptual merit to that, but in certain aspects or segments of the securitization market, it's common for sponsors to provide limited or more expansive guarantees to the whole pool just as a matter of industry practice. However, it doesn't necessarily mean that when a bank invests in a securitization, it is looking to the parent to back the credit supporting the securitization; they are still working through the assets. The guarantee is just incidental to the structure rather than the basis for the credit," Xu explained.
