Proposed Changes To HVCRE Rules Could Spur More Construction, Development Lending By Banks

A new bill working its way through Congress could loosen financial regulations stifling bank acquisition, development and construction lending.

The Clarifying Commercial Real Estate Loans Act, a bill introduced by Rep. Robert Pettenger in April, aims to clarify and adjust capital requirements for Highly Volatile Commercial Real Estate loans under Basel III.

“There are a lot of questions about the interpretation of [HVCRE rules]. There are idiosyncrasies in regulation that counter some of the goals of the regulation. The rule applies unevenly right now, in a lot of cases because it is poorly worded and constructed [and is] not aligned with the industry’s standard operating procedure,” CREFC Senior Director of Policy and Industry Analysis Christina Zausner said.

Breaking Down The Perks

The Clarifying Commercial Real Estate Loans Act passed a House committee on Nov. 7, and has since been read by the Senate twice and is now in the Committee on Banking, Housing and Urban Affairs.

Current HVCRE standards require borrowers to contribute at least 15% in cash to a deal, all of which must remain tied up in the project until the loan is paid in full. Under the revised bill, should borrowers wish to originate a similar loan to fund construction, they could count the appraised value for the land toward the borrower equity contribution — this means should the land increase in value, their cash contribution would be less due to rising revaluations. 

For example, if developer Jane Doe purchased land worth $1M several years ago that is now worth double, the value of her initial equity contribution would double too under the new bill, Zausner said. 

A Leg Up For Banks

The second major change presented in Pettenger’s bill could benefit banks in particular and encourage more lending in the construction and development space.

Currently, should a borrower wish to refinance a maturing HVCRE loan and reclassify the construction loan to a permanent loan (a normal 10-year fixed-rate loan), the lender would have to receive full payment and close out the loan entirely. Under these conditions, CREFC Executive Director Lisa Pendergast said banks run the risk of losing that loan to a competitor.

The clarified rule would allow banks to transition HVCRE loans to permanent loans once the project is stable, allowing banks to keep the loan on their books. 

“At this point, we recognize that we have banks and nonbanks. To some extent, the nonbanks see any kind of tightening of risk base capital requirements that banks must adhere to as a potential opportunity to step into that business,” Pendergast said. “My view is there is sufficient room for both banks and nonbanks.”

The Origins Of HVCRE

HVCRE loans came into effect following the financial crisis, and have somewhat dampened banks’ ability to lend to borrowers for construction and development projects. 

HVCRE designations were established under Basel III, a group of banking standards created by the Basel Committee on Banking Supervision and enforced under the Dodd-Frank Act.

Under Basel III, HVCRE loans are subject to a 150% weighting requirement, adding to a bank's total risk weight. Because the loans are riskier, regulations require banks to keep more capital on their books when lending.

The rule adversely affects both banks and borrowers. Obtaining riskier loans can result in higher rates and more convoluted lending requirements for borrowers. On the other hand, traditional lenders forced to adhere to these standards are less competitive, so the regulations put more money in the hands of their nonbank rivals. 

“The original legislation created a very competitive environment for the banks, [which are] losing construction loans to nonbank lenders not subject to Basel III,” Mission Capital Debt and Equity Finance Group Managing Director Ari Hirt said. “The benefit [of the revised rule] for the banks is significant. It is a benefit in not losing these loans when the project is complete.”

Though Basel III and the HVCRE classification came as of result of the financial crisis, today the rules are criticized for being onerous and unclear. Pettenger’s bill aims to clarify those gray areas for both lenders and borrowers.

“At the end of the day, you want to control development and new construction, and you want to make sure [banks] are prudently lending to those businesses,” Pendergast said. “The goal of those rules are all positive, except if it doesn’t help us streamline the interpretation of the rule, I’m not sure it does what it’s intended to do.”