As the New Year begins, we look ahead to new challenges and the opportunities they bring. 2015 quietly ushered in a new capital reserve rule for banks: a super capital charge for High Volatility Commercial Real Estate (HVCRE) loans. As the year closes, there are still many questions about this Rule and its effect.
Surprisingly many in the real estate and banking industries are only now beginning to see the Rule’seffect. In 2016, developers and lenders will face the challenge of wrestling with its impact. But a corresponding opportunity is arising for those who understand how to navigate the ever-changing labyrinth of regulation affecting commercial real estate.
An HVCRE loan requires that a bank retain 50% greater reserve on that loan compared to a non-HVCRE real estate loan. Put the intricacies of bank capital requirements aside. The take-away is that HVCRE loans are more expensive for banks to make. Accordingly, one of two things is happening: (1) banks are charging a higher interest rate for HVCRE loans; or (2) banks are structuring loans to avoid HVCRE status.
The solutions sound easy. They aren’t. First, existing commercial real estate loans are not grandfathered. Numerous existing HVCRE loans on banks’ books are poised to get hit with with the super capital HVCRE charge (if they haven’t already). If structure and pricing are locked in on these loans, there is little banks can do to recover their return on investment.
Second, even with new loans, questions swirl regarding how to qualify for the exclusions to the HVCRE Rule. Among other things, an exclusion to the Rule contains complicated timing considerations and potentially traps cash flows in the project. With any structure not squarely in the box, lenders are takingvery strict interpretations of the Rule’s requirements. These interpretations are particularly problematic when dealing with the complex capital structures required in some commercial real estate projects.At worst these limitationsscuttle projectsand stifle investment,and at best they increase the costs of projects.
Amidst the challenges, an opportunity emerges in 2016. Those that understand the Rule have an advantage in the marketplace. Firms, developers and lenders that understand HVCRE status, are proactive in addressing the structuring of CRE loans, and find creative ways to address the capital capital structure of new projects have the potential to sprint ahead of others.Regulators have given us a helpful FAQ as a starting point for understanding, but many questions still exist. We encourage all our clients take a hard look at their portfolios and pipelines and become proactive on addressing HVCRE loan structures.
 An HVCRE loan is defined as “a credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property.” 12 C.F.R. § 3.2. There are exclusions respecting certain classes of projects. Id.  HVCRE status can be avoided if the ADC loan meets loan-to-value, capital contribution requirements, and capital remains in the project throughout the life of the project.Id.  Often well drafted loan documents contain provisions allowing the lender to adjust the rate if there is a change of law making the loan more expensive for the lender.