As reported in a prior Client Alert, financial services reforms enacted into law on May 24, 2018,1 clarified the treatment of acquisition, development, and construction (ADC) loans characterized as high-volatility commercial real estate (HVCRE) exposures under the capital rules. Classification as an HVCRE exposure requires ADC loans to be risk-weighted at 150% under the capital rules, rather than the 100% risk-weighting accorded to other commercial loans.2 The new legislation provides that, to be subject to the 150% risk weight, HVCRE exposures must meet a new, narrower definition of “HVCRE ADC loans.” In other words, unless an HVCRE exposure meets the HVCRE ADC loan definition, it is subject to a 100% risk weight (unless it would carry another risk weight by reason of other circumstances, such as being in default).
On July 6, 2018, the federal banking agencies3 provided guidance on the impact of the legislative changes to the definition of HVCRE exposures (the “Guidance”).4 The Guidance is timely as the federal banking agencies have not had time to conform regulations or call report instructions to the new legislation. By reason of the Guidance, banks now know that they can rely on the new law for characterizing HVCRE exposures in their June 30 call reports, which are due by the end of this month.
PRINCIPAL TAKEAWAYS FROM THE GUIDANCE
- The legislative changes affecting the treatment of HVCRE exposures were effective immediately on May 24, 2018. As a result, depository institutions can assign the 150% risk weight to only those loans that meet the definition of “HVCRE ADC loans” under the statute.
- When reporting HVCRE exposures on their call reports, depository institutions may use available information to estimate and report as HVCRE exposures those loans that meet the definition of an “HVCRE ADC loan.” Depository institutions may refine these estimates as new information becomes available, but will not be required to amend previously filed reports. The Guidance provides an invitation for banks to re-characterize as non-HVCRE exposures (using the new definition) those ADC loans previously reported as HVCRE exposures under the old definition, provided information is available to justify the re-characterization. For example, it is clear under the new law that ADC loans for owner-occupied premises are not HVCRE exposures. It also is clear under the new law that ADC loans made before January 1, 2015 are not HVCRE exposures. Banks can review their HVCRE classified portfolios to determine whether such recharacterizations are justified.
- Alternatively, depository institutions can continue to risk-weight and report HVCRE exposures according to the definition currently contained in the instructions to the call report (in other words, the definition under the old regime) pending further action from the federal banking agencies.
- Bank holding companies, savings and loan holding companies, and intermediate holding companies are permitted to estimate and report HVCRE exposures on Schedule HC-R, Part II of the FR Y-9C in a manner consistent with the approach taken by their subsidiary depository institutions, in conformance with the new law.5