Recently, there have been suggestions that changes are possible regarding “high volatility commercial real estate” loans or “HVCRE” loans.
Here is a quick reminder of the issues. Effective January 1, 2015, all banking organizations were required to allocate significantly more capital when making commercial real estate loans that were considered to be HVCRE. Under these rules, an HVCRE loan had a risk weight for capital purposes 50% greater than the risk weight of a non-HVCRE commercial loan. Questions quickly arose.
An HVCRE loan is a loan that finances the acquisition, development or construction of real property prior to permanent financing. The regulations apply to existing loans as well as new loans.
There are important exceptions to this classification including: loans on one to four residential properties, community development loans, agricultural loans and certain qualifying real estate loans.
For real estate loans to qualify for the exception, the loan to value ratio must be less than or equal to the applicable maximum loan to value ratio (typically 80%), the borrower must have contributed capital in the form of cash or readily marketable assets equal to at least 15% of the project’s value as completed and the borrower’s contribution must be made before the lender advances funds. Furthermore, the capital contributed by borrower must be required to remain in the project throughout the life of the project. The life of the project is defined to end when the loan is converted to permanent financing, the project is sold, or the loan is paid in full.
Once a loan is classified HVCRE it cannot be declassified prior to the end of “life” of the project.
Here are the developments which now suggest changes may be on the horizon.
First, there have been federal legislative proposals about HVCRE. HR2148 has been introduced in the House that would clarify some aspects of the HVCRE definition. The bill would exempt loans made prior to January 1, 2015, from the HVCRE status and would permit a loan to be declassified once a project is completed and cash flow is being generated sufficiently to support interest payments and operating expenses.
Second, as part of its ongoing review of regulatory requirements, the Federal Financial Institution Examination Council reported this year that one of its goals is to clarify each HVCRE treatment for acquisition, development, and construction loans.
When FFIEC reported to Congress that it was considering simplifying community bank capital rules, it listed HVCRE exposure for review. The agencies involved, the Board of Governors, the Office of the Comptroller of Currency, and the Federal Deposit Insurance Corporation, noted that they had received a number of comments from community banks suggesting that the definition of HVCRE classification is not consistent with the safe and sound lending practices that the capital risk weighting requirement is too high, and that the requirement that the 15% borrower equity contribution, whether initially contributed or are internally generated, remain in a project for the life of the loan is not consistent with common business practices. The prohibition on removing capital has been interpreted in a manner that prevented withdrawal of capital when a construction loan was converting from temporary to permanent financing, for example.