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Changes to High Volatility Commercial Real Estate Capital Requirements

The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), signed into law on May 24, 2018, with immediate effect, amended multiple provisions of Dodd-Frank, including the capital requirements for loans secured by High Volatility Commercial Real Estate (“HVCRE”).  The higher capital requirements for HVCRE are part of the post- crisis financial market reforms and were implemented by U.S. bank regulators in 2015.  While the Act does not remove the HVCRE heightened capital requirement, it amends the approach in several important ways that limit the scope of its application and relieve some of the burdens of the requirements on lenders and borrowers. 

HVCRE heightened capital requirements in effect under U.S. banking regulation require that a 150 percent risk weight be assigned to loans that finance the acquisition, development or construction of real property.  The requirement generally excludes certain enumerated categories, including 1-4 family residential loans, agricultural loans, community development and commercial real property projects that meet specified loan-to-value and borrower contribution requirements.  The result for covered loans is 1.5 times the capital requirement that would otherwise be applicable to the lending bank for a non-HVCRE loan, and the accompanying cost and credit availability effects on commercial real estate borrowers.  The Act features several important changes and clarifications to the HVCRE requirements, including:

  • The prior requirement, implemented in 2015, was not explicitly limited to loans made after it became effective.  The Act includes an explicit exclusion for any loan made prior to January 1, 2015.

  • The Act creates a new defined term “HVCRE ADC Loan” (High Volatility Commercial Real Estate Acquisition, Development or Construction loan), which is narrower than the pre-existing HVCRE category, in that the loan must also “primarily” finance the acquisition, development or construction of real property, have the purpose of financing the conversion to income-producing real property and be dependent on future income (versus in place income) or proceeds from the real property.  Improvements to existing income-producing real property would not be covered if the cash flow already generated by the existing real property is able to cover debt service and expenses.

  • Under the existing requirement, the Act limits the types of borrower contributions that can be considered for satisfying the 15 percent threshold for exclusion from HVCRE heightened capital.  Significantly, the Act allows the use of the appraised value of any land contributed to the project, meaning that borrowers can now get credit for appreciation of contributed land above the purchase price paid.

  • Finally, the Act creates a more flexible off ramp from HVCRE treatment.  Under the previous regime, the heightened requirement would remain in place until replacement with permanent financing.  The Act allows “reclassification” to a non-HVCRE loan upon substantial completion of the project or the point at which cash flow from the real property becomes sufficient to cover the debt service and expenses.

While the HVCRE requirements are still an important potential financing difficulty to consider when evaluating a project, the changes accomplished by the Act are a helpful development to limit the scope and duration of application of the heightened capital requirements.

© Polsinelli PC, Polsinelli LLP in California


About this Author

Kraig Kohring, Polsinelli Law Firm, Kansas City, Real Estate and Finance Law Attorney

Kraig Kohring’s clients benefit from his strong background in financial services. As chair of the Real Estate and Financial Services Department and group chair for the Capital Markets & Commercial Lending practice, Kraig focuses his personal practice on commercial and asset-based lending transactions, securitization and other structured finance transactions, tax credit finance and related transactions, and commercial loan enforcement. A primary area of his practice includes representing lenders in asset-based credit facilities. He represents national lenders and...

Joseph Aaker, Polsinelli Law Firm, Kansas City, Finance Law Attorney

Joe Aaker focuses his practice on commercial and asset-based lending transactions, securitization and other structured finance transactions. Joe has a wide range of experience in financial products and markets transactions and regulatory advice. He has represented sell side and buy side clients in complex financial transactions, including structured finance, over-the-counter derivatives, cleared derivatives and securities.

Joe was previously an assistant general counsel at a large investment bank where he: 

  • Negotiated derivatives in securitizations and asset-based lending;

  • Led interpretation, advocacy and implementation efforts for several aspects of financial market reform

  • Represented the bank in many exams and inquiries by prudential and market regulators

  • Counseled clients on securities and commodities laws, broker-dealer regulations and financial market insolvency considerations.

Joe’s in house experience gives him a practical perspective that allows him to understand and meet the needs of financial institution clients. 
Joe has extensive experience in negotiation and documentation of derivatives and other financial products, including ISDA master documentation and regulatory protocols, repurchase transactions, prime brokerage agreements, cleared derivatives documentation and associated collateralization arrangements.