Over the past weeks, the US Federal Reserve (Fed) has enacted a number of changes to monetary policy as well as regulatory and supervisory practices with the aim of supporting US financial markets—and the economy more broadly—during the COVID-19 pandemic.
Some of these policy changes are unprecedented in size and scope, underscoring the belief that the Fed under Chair Jerome Powell will use all means necessary to combat the economic impact of the crisis.
Additional measures may still be taken in the coming weeks, but the Fed’s recent actions already support liquidity and tenant demand within the real-estate sector—and may perhaps prevent a more severe contraction in the industry.
COVID-19’s Impact on Commercial Real Estate
The economic shutdown has already impacted commercial real estate as retail stores, restaurants, medical and dental offices, hotels and many other establishments close—driving a surge in forbearance requests and elevating the risk of mortgage defaults.
Many multifamily renters are now unemployed, leading to a potential rise in delinquencies despite moratoria on evictions for lack of rent payment while the stresses on commercial real-estate demand drove an almost overnight surge in risk. Most lenders have projected potential losses in portfolios and cap rates are likely to rise by at least 50 to 100 basis points.
The extent of the impact on property values is yet to be determined, but the Fed has already eased monetary policy, introduced liquidity facilities, and loosened regulatory guidance for financial institutions to combat the following:
- Potential liquidity crunch
- Rise in mortgage defaults
- Business closures
This unprecedented level of market intervention is necessary to support the economy during this crisis. As with any action without precedent, however, the longer-term implications of this surge of capital—and whether these programs can be systematically wound down without market disruption—are unknown.
Five Types of Major Federal Reserve Actions
The Fed has relaxed regulatory oversight and introduced several liquidity tools in the past few weeks. The unprecedented size and scope of this market intervention has expanded the Fed balance sheet substantially and will drive further balance-sheet growth in the coming months.
Major actions taken in response to the COVID-19 pandemic generally fall into five categories.
Easing General Monetary Conditions
General monetary conditions are designed to expand reserves in the banking system and allow for lower credit costs. This is accomplished through the implementation of a variety of short-term credit instruments that are priced off the rate for federal funds, which is the Fed’s key policy rate.
To fight the economic slow-down caused by COVID-19, the Fed has added agency commercial mortgage-backed securities to its quantitative easing (QE) program. QE specifically allows for the purchase of securities on the open market without limit. This policy aims to support the flow of credit to the multifamily market through agency lending.
Suspension of Reserve Requirements
The elimination of reserve requirements effectively boosted the so-called money multiplier, since no reserves are required to be held against deposits. During this time, when there is a flight to cash, the banking system risked having to hold more reserves as deposits increased sharply. To allow the banking system the maximum ability to lend, the Fed temporarily suspended reserve requirements. Because of deposit insurance, this action will not induce depositors to cause a run on the banking system.
Lower Short-Term Policy Interest Rates
Short-term interest rates are one factor in determining the term-structure of rates. Consequently, the Fed’s general monetary ease has brought down the entire yield curve of rates. Although interest rate levels have not been a major impediment to capital spending, investing in real estate, or making term purchases of consumer durable goods, a lower rate environment can not hurt. To the extent that commercial real estate is transacted, the lower rate environment can provide for lower-cost mortgages, though economic volatility can also widen spreads, and boost the discounted value of given net rental flows.
Providing Liquidity to Financial Markets
The Fed acted quickly when stresses started to appear in financial markets due to COVID-19, which prevented financial markets from freezing and allowed a continued flow of credit to all sectors of the economy. In the last month, these actions have increased the Fed balance sheet by more than a trillion dollars to nearly $6.62 trillion by the fourth week of April, 2020.
Paycheck Protection Program Liquidity Facility
One of the most important liquidity facilities for commercial real estate is the Paycheck Protection Program Liquidity Facility (PPPLF).
Commercial real estate is impacted most by net-rental income, which makes it important to preserve tenants’ ability to conduct business and pay rent. The PPPLF allows lenders to make Paycheck Protection Program (PPP) loans to small businesses that are under stress. Lenders can then sell those loans to the Fed at par and continue to make additional PPP loans.
In addition to payroll, PPP loans may be used for mortgages, rent, and utilities. To the extent the program is used by small businesses, it can help preserve rent and mortgage payments. For small- and medium-sized businesses, these loans can serve as a bridge to the time when restrictions are lifted. In the interim, they may partially preserve rent flows to real estate investors and mortgage flows to lenders.
Main Street Lending Program
The Main Street Lending Program (MSLP) is another important program for small- and medium-sized business with up to $2.5 billion in revenue and up to 10,000 employees.
The MSLP can be tapped by real-estate investment trusts, investment companies, and other entities that fall under qualifying guidelines. If net rent flows to real-estate companies degrade to the extent the company is at risk for meeting its obligations—mortgage payments and payroll, for example—then the company can tap into the MSLP for up to a four-year loan with no pre-payment penalty.
The MSLP can also be used by tenant companies under financial stress because of COVID-19 restrictions. To the extent they’re used by qualifying tenant companies, those loans can preserve rent flows to property owners, and thereby mortgage flows to lenders.
Commercial Paper Funding Facility
Large businesses that have direct access to capital markets may be assisted by the Commercial Paper Funding Facility (CPFF). The CPFF is designed to support the commercial paper market for large firms that typically use unsecured short-term borrowing through the issuance of commercial paper. The CPFF is intended to ensure the commercial paper market clears, and if it’s at risk not to clear, the Fed will step in to purchase commercial paper.
The Fed moved quickly during this market disruption to provide liquidity with the aim of preventing the seizing of the commercial paper market—which could put at risk those firms that regularly use commercial paper.
Primary Market Corporate Credit Facility
The Primary Market Corporate Credit Facility (PMCCF) also provides liquidity to the corporate bond market. This facility acts the same way as the CPFF, except that it’s for corporate bonds with a longer maturity.
It allows firms with access to capital markets to borrow longer term in the bond market without fear the bond market will either not function well or freeze. This source of borrowing by larger firms can be used for all obligations, including rent and mortgage payments.
Other Key Actions
- Adding $1.5 trillion of liquidity to the repurchase market—a key source of short-term funding
- Establishing the Term Asset-Backed Securities Loan Facility (TALF) to support the flow of credit-to-debt securities backed by auto loans, credit-card receivables, student loans, and Small Business Administration loans—the size of the TALF was expanded on April 9
- Creating the Money Market Mutual Fund Liquidity Facility to provide liquidity to money-market mutual funds and municipalities by extending the range of securities eligible for purchase to include variable-rate demand notes and bank CDs
- Establishing the Municipal Liquidity Facility, which offers up to $500 billion in lending to states and municipalities
- Creating the Primary Market Corporate Credit Facility (PMCCF) to provide liquidity for new corporate bond and loan issuance—the size of the PMCCF was expanded on April 9
- Establishing the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds—the size of the SMCCF was expanded on April 9
- Creating the Primary Dealer Credit Facility to provide liquidity to primary dealers, the dealers through which the US Treasury sells newly issued securities
- Establishing an international repurchase facility whereby international monetary authorities can repurchase US Treasury securities in exchange for US dollars
- Enacting dollar-swap arrangements with foreign central banks
Directly Expanding Fed and Bank Lending
The Fed has encouraged the financial institutions it regulates to take the following actions:
- Participate in the Treasury Department’s Economic Injury Disaster Loan program
- Participate in the PPP
- Utilize the discount window without stigma
- Offer small-dollar loans to consumers and small businesses in response to COVID-19
- Make use of intraday Federal Reserve credit, also known as the daylight credit
Easing Regulatory Requirements
The Fed has eased the following requirements:
- Liquidity and capital requirements for lenders, allowing for more robust lending to households and businesses
- The leverage ratio for holding companies it regulates, excluding US Treasury securities and deposits at the Fed in the calculation of the ratio—the change would effectively reduce tier-1 capital by about 2% points system-wide
- Deadlines for some reporting requirements, including the FR Y-9C and the FR Y-11
The Fed has encouraged lenders to work with stressed borrowers affected by COVID-19. This should make it easier to restructure debt if the slipping loan performance and restructuring is the result of COVID-19 mitigation policies.
Troubled Debt Restructuring Loans
For loans that were current before COVID-19 but were restructured because of it, the Fed is allowing lenders to not designate those loans as Troubled Debt Restructuring loans. This policy has a positive impact on a lender’s allowance calculations and a borrower’s credit rating.
CARES Act and CECL Methodology
The Fed has provided clarity to financial institutions on the relationship between the Coronavirus Aid, Relief, and Economic Security (CARES) Act and Current Expected Credit Losses (CECL) methodology. The goal of the CARES Act is to ease the reporting of credit losses due to COVID-19.
Many of the Fed’s actions in response to COVID-19 have a direct impact on real-estate firms—and an indirect impact on the commercial real-estate sector through the support of tenants, households, and lenders.
This unprecedented financial support is broad and should help the commercial real-estate sector weather the storm of COVID-19. It’s also worth noting some of the Fed’s programs may need to increase—as has already occurred in some instances.
However, despite this broad-based financial support, the extent of the impact on commercial real estate is still unknown. Factors that will have an effect include the likely uptick in vacant space throughout most sectors as well as tenants that will continue to seek forbearance—contributing to a decrease in property values.
The easing of monetary policy in the near term may also spur a higher rate of inflation once local economies recover. While many investors expected the low interest-rate regime to persist prior to COVID-19, the resulting inflation may ultimately lead to higher interest rates.
These questions—as well as how the Fed can wind down its balance sheet without disrupting markets—are important, but the Fed has decided they’re secondary to resolving the crisis at hand and preventing a greater downturn. Hopefully, the efforts to maintain liquidity and provide support for businesses will prevent a more precipitous decline in the commercial real-estate sector than would otherwise occur.
We’re Here to Help
To learn more about how the Fed’s recent actions might affect your commercial real-estate business or holdings, contact your Moss Adams professional.
Note on COVID-19
During this unparalleled time, we’re closely monitoring the COVID-19 situation as it evolves so we can provide up-to-date guidance and support to help you combat uncertainty. For regulatory updates, strategies to help cope with subsequent risk, and possible steps to bolster your workforce and organization, please see the following resources: