How HVCRE Changed This Week

WASHINGTON, DC–Earlier this week the House of Representatives passed legislation to loosen Dodd-Frank Act rules for small and midsize banks. On Thursday President Trump signed the measure into law.

The bill had only a tangential effect on commercial real estate — except in one respect, which were the changes to Basel III’s High Volatility Acquisition, Development and Construction (HVCRE) financial requirements.

“The main impact on CRE is the improved detail surrounding those circumstances in which banks are required to hold a 150% risk weight (the 12% capital requirement) for CRE loans vs a 100% risk weight (the 8% capital requirement),” Heidi Learner, chief economist at Savills Studley, tells GlobeSt.com.

In short, the new law provides context on when an HVCRE loan may be reclassified to a non-HVCRE loan. “This clarification is beneficial for borrowers, since it will free up additional capital,” Learner says.

“The old legislation stated that the capital contribution of a borrower had to remain in the life of the project — i.e., permanent financing was secured or the loan was paid in full,” she says. “The new legislation provides those terms when a loan may be reclassified to a non-HVCRE loan — which was entirely missing from the prior guidance.” Additionally, Learner says, there is clarity on the contributed capital (against, what counts toward the borrower’s 15% requirement to be exempt from HVCRE classification) in the form of land, which eliminates some of the confusion the FDIC, OCC and Fed had tried to address in 2015 in a FAQ, particularly regarding its current value vs. purchased value.

Learner provided the following language from the two bills as well as from a FAQ from FDIC, annotated with boldface, to make her point.

From the old legislation

High volatility commercial real estate (HVCRE) exposure means a credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances:

(1) One- to four-family residential properties;

(2) Real property that: (i) Would qualify as an investment in community development under 12 U.S.C. 338a or 12 U.S.C. 24 (Eleventh), as applicable, or as a ‘‘qualified investment’’ under [12 CFR part 25 (national bank), 12 CFR part 195 (Federal savings association) (OCC); 12 CFR part 228 (Board)], and (ii) Is not an ADC loan to any entity described in [12 CFR part 25.12(g)(3) (national banks) and 12 CFR 195.12(g)(3) (Federal savings associations) (OCC); 12 CFR 208.22(a)(3) or 228.12(g)(3) (Board)], unless it is otherwise described in paragraph (1), (2)(i), (3) or (4) of this definition;

(3) The purchase or development of agricultural land, which includes all land known to be used or usable for agricultural purposes (such as crop and livestock production), provided that the valuation of the agricultural land is based on its value for agricultural purposes and the valuation does not take into consideration any potential use of the land for non-agricultural commercial development or residential development; or

(4) Commercial real estate projects in which: (i) The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio in the [AGENCY]’s real estate lending standards at [12 CFR part 34, subpart D (national banks) and 12 CFR part 160, subparts A and B (Federal savings associations) (OCC); 12 CFR part 208, appendix C (Board)]; (ii) The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s appraised ‘‘as completed’’ value; and (iii) The borrower contributed the amount of capital required by paragraph (4)(ii) of this definition before the [BANK] advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project. The life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full. Permanent financing may be provided by the [BANK] that provided the ADC facility as long as the permanent financing is subject to the [BANK]’s underwriting criteria for long-term mortgage loans.

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‘(d) RECLASSIFICATION AS A NON-HVRCE ADC LOAN.—For purposes of this section and with respect to a credit facility and a depository institution, upon— ‘‘(1) the substantial completion of the development or construction of the real property being financed by the credit facility; and ‘‘(2) cash flow being generated by the real property being sufficient to support the debt service and expenses of the real property, in accordance with the institution’s applicable loan underwriting criteria for permanent financings, the credit facility may be reclassified by the depository institution as a Non-HVCRE ADC loan.

From FDIC’s FAQ in 2015

If cash is used to buy land, and that land is subsequently contributed to a new development, can the land still count as contributed capital? Does the banking organization need to document when and how much the borrower paid for the land?

Yes. If cash is used to purchase land that is subsequently contributed to an ADC project, the cash used to buy the land can count toward the 15 percent contributed capital amount. This 15 percent requirement must be met before the banking organization advances funds. The definition of HVCRE excludes CRE projects in which the borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s “as completed” value. (See definition in question 6.) Consistent with the preamble to the regulatory capital rule, cash used to purchase land is a form of borrower-contributed capital under the HVCRE definition. The banking organization should document the details pertaining to the amount of cash paid for the land.

From the new legislation

‘(c) VALUE OF CONTRIBUTED REAL PROPERTY.—For purposes of this section, the value of any real property contributed by a borrower as a capital contribution shall be the appraised value of the property as determined under standards prescribed pursuant to section 1110 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (12 U.S.C. 3339), in connection with the extension of the credit facility or loan to such borrower.