High Volatility Commercial Real Estate (HVCRE) Rule
The HVCRE Rule
In July 2013, U.S. banking regulators issued the Basel III Regulatory Capital and Market Risk Rules. That issuance included a High Volatility Commercial Real Estate (HVCRE) rule, under which certain acquisition, development and construction (ADC) loans are subject to a 150 percent risk weight. The rule became effective January 1, 2015.
Banks found the HVCRE rule to be insufficiently clear and found that it did not accurately reflect the risks of prudent ADC lending. As a result, many banks overclassified ADC loans as HVCRE (holding higher capital for ADC loans that lacked the higher risk the HVCRE rule was intended to capture) and reduced their ADC lending. Banks' ability to compete for sound, prudently underwritten ADC loans were impaired.
MBA was able to successfully advocate for legislation to address the weaknesses in the HVCRE rule. To accomplish that, MBA pursued a dual-path advocacy approach, focusing both on the federal banking regulators and Congress.
When the HVCRE rule became effective, MBA and its members raised numerous questions and concerns with the federal banking agencies regarding how to apply the HVCRE rule. In response, the agencies issued a set of joint FAQs in March 2015. The FAQs, however, did not provide sufficient clarity or flexibility to the rule, and in some cases, raised more questions than it answered, so MBA and its members continued to seek guidance. The agencies did not issue any further guidance. On the legislative path, MBA actively supported H.R. 2148, a bipartisan bill introduced by Congressmen Robert Pittenger (R-NC) and David Scott (D-GA) on April 26, 2017, to address the current HVCRE rule. Specifically, the legislation would clarify the application of the rule and better align HVCRE capital treatment with factors affecting credit risk, as follows:
- Clarify the definition of an "HVCRE ADC Loan" (i.e., secured real property ADC loans where repayment is dependent upon future income/sale proceeds of such property);
- Clarify that loans to acquire or improve existing, performing, income-producing properties that meet financial institution's applicable loan underwriting criteria for permanent financing are not HVCRE ADC loans;
- Permit banks to count the value of appreciated property toward borrower's required 15 percent capital contribution;
- Remove mandatory restrictions on removing internally generated capital for life the loan;
- Permit banks to allow borrowers to remove contributed capital from a project when a bank determines that project meets financial institution's applicable loan underwriting criteria for permanent financing;
- Authorize banks to withdraw HVCRE status prior to the end of an ADC loan when a bank determines that a project meets underwriting requirements for permanent financing; and
- Exempt loans originated prior to January 1, 2015.
On October 27, 2017, while H.R. 2848 was pending in the House, the banking agencies issued a proposal to amend the HVCRE rule. They proposed to replace it with a High Volatility Acquisition, Development or Construction (HVADC) rule. Among other changes, the HVADC rule would reduce the risk weight from 150 percent to 120 percent. However, it also would eliminate the capital contribution exemption, which permits a bank assign a 100 percent risk weight for an ADC loan where: (1) the loan met certain LTV standards; (2) the borrower contributes at least 15 percent capital; and (3) the bank sufficiently restricts the withdrawal of capital. While the proposal had some merit, all in, it would have been even worse for bank ADC lending. The loss of the capital contribution exemption would be particularly harmful.
During the comment period for the HVADC proposal, the House Financial Services Committee amended H.R. 2848 to incorporate some clarifying language from the HVADC proposal, but the Committee did not otherwise change the bill. MBA supported that change. The full House then passed the bill with a voice vote in November 2017.
In December 2017, MBA responded to the banking agencies' HVADC proposal, submitting extensive comments opposing substantial portions of the HVADC proposal. MBA also led a coalition letter opposing the proposal. The agencies never finalized the HVADC proposal.
In February 2018, Sen. Tom Cotton (R-AR) and Doug Jones (D-AL) introduced S. 2405, which is very similar to H.R. 2848 as passed by the House. With strong MBA advocacy, a comparable HVCRE provision then was added to the Senate's larger, regulatory relief package - S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act. That bill passed both chambers of Congress and was signed into law by President Trump May 24, 2018.
The new law superseded contrary provisions of the banking agencies' risk-based regulations, effective immediately, so MBA urged the federal banking agencies to provide guidance to banks pending the completion of a rulemaking to update their regulations. July 6, 2018, the federal banking agencies responded, issuing interim guidance to banks, recognizing the change in the law, and providing banks with the flexibility to report HCVRE exposures under the existing rules or under the new law, pending a rulemaking by the banking agencies to amend the HVCRE rule.
September 28, 2018, the federal banking agencies published proposed amendments to their risk-based capital regulations to conform them to the HVCRE provisions in S. 2155. MBA will submit comments, which are due by November 11, 2018.
MBA strongly recommends that the federal banking agencies implement the HVCRE provision of S. 2155 in a manner that provides the clarity and relief that Congress intended to provide.