As we mentioned just a couple of weeks ago, the federal banking regulators have taken aim at the risk weighting rules for High Volatility Commercial Real Estate (“HVCRE”) loans that went into effect back in 2015. In a proposal published on September 27, 2017, the regulators seek to simplify the approach in several ways. First, the existing HVCRE definition in the standardized approach would be replaced with a simpler definition, called HVADC, which would apply to credit facilities that primarily finance or refinance ADC activities. Second, an HVADC exposure would receive a 130 percent risk weight.as opposed to the 150% risk weight for HVCRE exposure under the existing rule. The tradeoff though is that HVADC would apply to a much broader set of loans. For example, as compared to the HVCRE exposure definition, the proposed HVADC exposure definition would not include an exemption for loans that finance projects with substantial borrower contributed capital and consequently removes the restriction on the release of internally generated capital.
The definition of “primarily finance” means credit facilities where more than 50 percent of loan proceeds will be used for ADC activities. So for example, multipurpose facilities where more than 50 percent of loan proceeds finance non-ADC activities, such as the purchase of equipment, would not be considered HVADC.
As with the HVCRE rule, there are certain exemptions. HVADC would exempt permanent loans, community development loans, loans for the purchase or development of agricultural land and loans for one to four family residential. Thus, lot development loans and loans to finance the ADC of townhomes or row homes would not be considered HVADC but raw land loans and loans to finance the ADC of apartments and condominiums generally would be considered HVADC.
Real property projects that have the primary purpose of “community development” would not be considered HVADC. Loans to finance activities that promote economic development by financing businesses or farms that meet the size eligibility standards of the Small Business Administration’s Development Company or Small Business Investment Company programs or have gross annual revenues of $1 million or less also would not be considered HVADC so long as they meet the applicable public purpose test.
Finally, a “permanent loan” would be defined to mean a loan prudently underwritten that has a clearly identified ongoing source of repayment sufficient to service amortizing principal and interest payments aside from the sale of the property. Bridge loans generally are not considered to be “permanent loans” and generally would be considered HVADC. Owner-occupied ADC projects may have sufficient capacity at origination to repay the loan from ongoing operations, in which case the loan would be considered a “permanent loan” and would not be considered HVADC. Interest-only loans could be “permanent loans.” Although the bank must identify a source of repayment that is sufficient to service an amortizing payment, the proposed rule would not require that the current loan payments be amortizing for a loan to be considered a “permanent loan.”
The simplification of the rule should be greatly welcomed. The HVCRE rule has proven to be an extremely difficult rule to apply, particularly the requirement that the borrower would not be allowed to take out any internally generated profits from the project for the life of the loan. Whether the revised rule actually makes a difference on the bottom line is harder to ascertain at this point.