After the 2008 recession, the Federal Reserve started monitoring some of the nation’s largest banks to ensure that they would have sufficient capital to withstand another similar financial downturn. One way that the central bank has done so is through an annual “stress test,” and on Feb. 3, the Fed announced that the 2017 test would place a greater emphasis on commercial real estate loan exposure than it has in the past. This could have an effect on California companies that are developing new commercial projects and or in the midst of financing negotiations.
For the 2017 test, the banks have been asked to prepare for a scenario where the U.S. unemployment rate increases dramatically to 10 percent, the Dow and other financial indexes plummet and countries around the world decrease their manufacturing output. The test differs from previous ones in that it also hypothesizes significant declines in commercial real estate values. The banks will be required to submit their responses by April 5, and the Federal Reserve will release the results in June.
One concern shared by both the Fed and regulators such as the Office of the Comptroller of the Currency is that the banking industry has been increasingly participating in higher-yield real estate loans due to low interest rates in other areas. As a result, some lenders have lowered their underwriting standards.
The financial institutions that do not pass the test may be forced to stop making new loans until they increase their capital reserves. This could be problematic for a developer who has already received a written financing commitment for a proposed commercial real estate project. If the bank is unwilling or unable to fulfill that obligation, the developer may want to meet with an attorney to see whether litigation might be necessary.