The U.S. House of Representatives passed H.R. 2148, the Clarifying Commercial Real Estate Loans Act on Tuesday by a voice vote. The bill was put together in response to the confusion caused by the high-volatility commercial real estate, or HVCRE, loan classification that was introduced by the Basel III regulatory framework. The legislation, introduced in April by Reps. Robert Pittenger (R-N.C.), and David Scott (D-Ga.), had passed the House Financial Services Committee last month with 14 co-sponsors. The bill will now go before the Senate.
H.R. 2148 has received industry kudos, and for good reason. The bill’s purpose is to clarify how an HVCRE loan is classified. The HVCRE rule increased the risk weighting of a loan held on a bank’s balance sheet by 50%, so banks are required to hold capital totaling 12% against such loans, up from 8% for most commercial mortgages. But the rule didn’t exactly spell out what would cause a loan to be classified as HVCRE.
How to Spell HVCRE
A loan – typically an acquisition, development and construction, or ADC loan – would be classified as an HVCRE loan if it had a loan-to-value ratio (LTV) of more than 80%, and if its sponsor (or borrower) had put up less than 15% of the collateral’s equity, based on the project’s completed value. It also receives the classification if the sponsor is able to recover any excess cash flow from the collateral – typically a construction project – during the loan’s life.
Meanwhile, the rule dictated that only the amount paid for a land parcel could be used in calculating whether a sponsor had met the 15% equity contribution standard. This can only be applied if the price is being used as part of a sponsor’s equity. To boot, the amount cannot be its value at contribution, which had been the norm.
The rule led to a mish-mash of interpretations by lenders, and threw a proverbial monkey wrench into the loan syndication business, simply because one bank might interpret the rule differently than another. In addition, some banks shied away from lending (even against income-producing properties) if they included any sort of redevelopment or construction component.
Much-Needed Clarity to Come
H.R. 2148 was put together to provide clarity. For instance, it spells out that an HVCRE loan is a “credit facility secured by land or improved real property that … finances or has financed the acquisition, development or construction of real property.” The bill also states that an HVCRE loan funds the acquisition, development or improvements to a property to make it into “income-producing real property, and is dependent upon future income or sales proceeds from, or refinancing of, such real property for the repayment of such credit facility.”
The bill also provides an HVCRE exemption for loans used to acquire or finance income-producing properties, or improvements to such properties.
While the legislation keeps the 15%-equity requirement for a loan to be exempt from the HVCRE classification in place, it would allow for any excess equity to be withdrawn as it’s built up. In addition, it clarifies that a borrower’s equity contribution would be based on a recent appraisal, as opposed to its purchase price.
The bill also defines exactly when a loan that’s classified as HVCRE could be converted to a non-HVCRE loan: when construction is complete and property-level cash flow exceeds that needed to service the loan. That’s something that was missing. The proposed legislation would also exempt loans originated before 2015, when the HVCRE rule went into effect.
What Comes Next?
The Mortgage Bankers Association applauded the voice vote, saying that the legislation would “allow lenders to better meet the needs of their borrowers and will also support the overall commercial real estate finance ecosystem.”
In hearings held earlier this week on the legislation, Rep. Carolyn Maloney (D-N.Y.) proposed simplifying the calculations used to determine the equity value of property contributed as equity for projects. Rep. Keith Rothfus (R-Pa.) said the bill was a response to the fact that “bank lending in today’s regulatory environment is weak. We need to jump-start our economic growth once again, so we are going to need to find ways to address some of the unintended consequences of the rules coming out of Washington, D.C.”
The information provided is based on information generally available to the public from sources believed to be reliable.