We have written several times about the rules concerning the appropriate risk weighting for High Volatility Commercial Real Estate (“HVCRE”) loans. The interagency FAQ published on April 6, 2015 provided some guidance but many banks continue to have questions about fact situations that are either not addressed under the regulation. Despite indications that an interagency task force was looking at a further set of FAQ nothing has yet come out. Despite that, there are actually grounds for optimism that the rules will yet be simplified.
Section 2222 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) requires that, not less than once every 10 years, the Federal Financial Institutions Examination Council (FFIEC) and the Board of Governors of the Federal Reserve System (Board), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) must conduct a review of their regulations to identify outdated or otherwise unnecessary regulatory requirements imposed on insured depository institutions. In conducting this review, the statute requires the FFIEC or the agencies to categorize their regulations by type and, at regular intervals, provide notice and solicit public comment on categories of regulations, requesting commenters to identify areas of regulations that are outdated, unnecessary, or unduly burdensome.
In late spring of this year the FFIEC reported to Congress that one of its goals was to simplify the capital rules for community banks. The very first area of attention listed under that heading was to replace the complex treatment of HVCRE exposures with a more straightforward treatment for most acquisition, development, or construction (“ADC”) loans. While the agencies are not ready to lift the curtain on what the revised rule might look like they did cite certain comments they had received from community banks including (i) that the definition of HVCRE is neither clear nor consistent with established safe and sound lending practices; (ii) the 150 percent risk weight applied to HVCRE lending is simply too high; (iii) the criteria for determining whether an ADC loan may qualify for an exemption from the HVCRE risk weight are confusing and do not track relevant or appropriate risk drivers; and (iv) in particular, commenters expressed concern over the requirements that exempted ADC projects include a 15 percent borrower equity contribution, and that any equity in an exempted project, whether contributed initially or internally generated, remain within the project (i.e., internally generated income may not be paid out in the form of dividends or otherwise) for the life of the project.
The last point about whether internally generated equity can be removed from a project during the life of the project has proven to be one of the more controversial issues. While most bankers could get comfortable with the requirement for borrower equity to be injected into the project prior to the bank’s contribution of funds and kept the for the life of the project, the prohibition on borrowers pulling internally generated equity out of the project prior to converting it to permanent financing never has seemed to make much sense to banks or developers.
Another hot button issue with the HVCRE rule is the requirement that contributed real estate must be valued for purposes of determining the borrower’s equity as of the date the real property was acquired as opposed to its current fair market value. That particular issue is actually the subject of proposed legislation in Congress that would allow the parties to use the current market value. Whether the bill progresses further is difficult to predict but the FFIEC will clearly be aware of it as they reexamine this portion of the HVCRE rule.