Last week, the Senate passed the Economic Growth, Regulatory Relief and Consumer Protection Act (S. 2155). Primarily, the bill aims to ensure consumer protections and adequate access to mortgage credit. Specific to the commercial and multifamily real estate sectors, it takes another big step forward in clarifying the widely criticized High Volatility Commercial Real Estate (HVCRE) rule that was first introduced as part of Basel III regulations.
Broadly speaking, the bipartisan bill reduced the burden on smaller lenders from some of the toughest requirements of the Dodd-Frank Act, such as the Volcker Rule. There has been a recognition that some of the provisions in the Dodd-Frank-era reforms were applied perhaps too broadly and the net caught too many small fish, says Martin Schuh, senior director and head of government relations at the CRE Finance Council. This bill aims to remedy that problem and alleviate some of the regulatory burden, he adds.
The HVCRE rule effectively raised the capital reserve requirement for qualifying acquisition, development and construction loans. The intent was to provide some added safeguards for higher credit risk by backing those loans with more cash reserves. Historically, banks were required to set aside 8 percent of the value of those loans. Under the HVCRE rule, the required amount of capital increased to 12 percent or a 150 percent risk weighting.
Since the new rule went into effect in January 2015, banks have become increasingly frustrated with poor guidance on what loans qualify as HVCRE. Further adding to the confusion is a new proposal by regulators that was introduced last fall that would replace HVCRE with a new amended HVADC rule (high volatility acquisition, development, construction).
“For the most part, our membership was having a difficult time adhering to the new HVCRE rule. And when you toss in this new HVADC layer on top of it, it really, really muddied the waters,” says Schuh. “So this is going to bring an element of certainty to what was an open question.”
Bill provides new guidelines
Previous versions of HVCRE legislation—H.R. 2148 and S. 2405 Clarifying Commercial Real Estate Loans—were incorporated into S. 2155. In addition, it is important to note that the proposed legislation is not a “rollback” on regulations pertaining to HVCRE loans. The additional risk weighting for high risk loans remains in place.
“As it’s currently written, we and a lot of other stakeholders think that the current regulatory regime is not sufficiently clear. So it is causing some loans to trigger HVCRE status and a higher 150 percent risk weight,” says Bill Killmer, senior vice president for legislative and political affairs at the Mortgage Bankers Association (MBA). The current bill does a better job of clarifying what would trigger HVCRE status, he adds. According to the MBA, some of the modifications in the Senate bill include the following provisions.
For example, one of the criticisms of the original rule had been that contributed land value on a construction loan was valued at the price of the last sale, even if that sale was 40 years ago. It was a huge negative for owners who had held property for a long time and didn’t get credit for any appreciation. The new rule allows contributed land to be valued at current appraised value.
- More precisely define an HVCRE acquisition, development or construction (ADC) loan, such as a secured real property ADC loans where repayment is dependent upon future income/sale proceeds of the property.
- Permit banks to count the value of appreciated property toward the borrower’s required 15 percent capital contribution.
- Permit withdrawal of contributed capital once project meets underwriting requirements for permanent financing.
- Permit withdrawal of HVCRE classification prior to the end of an ADC loan once project meets underwriting requirements for permanent financing.
- Permit withdrawal of internally generated capital throughout the life of the project.
- Exempt loans originated prior to January 1, 2015.
In the wake of the Senate vote, the bill now moves to the House. Financial Services Committee Chairman Jeb Hensarling (R-TX) has indicated that the House plans to add a number of provisions, which would likely send the amended bill back to the Senate for another vote. However, even with additional modifications, many believe that that the bipartisan bill will remain on course to be signed into law before the August recess. If it is signed into law, it would supersede the HVADC proposal, which will likely prompt regulators to withdrawal that proposal.
“Our view is that (S. 2155) is a step in the right direction. However, it really doesn’t impact some of our larger institutional members,” says Lisa Pendergast, executive director of the CRE Finance Council. The CRE Finance Council would like to see Congress also address aspects of the Volker Rule that have negatively impacted the secondary market liquidity. The CMBS market has been treated very harshly in terms of the capital requirements that can make it very expensive to participate and provide the liquidity that the CMBS market was accustomed to prior to the crisis, she adds.