This week, Congress passed the first major piece of legislation to alleviate the regulatory burden created by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which was signed into law in 2010. Aiming to cut numerous restrictions imposed on banks and financial institutions by the Dodd-Frank response to the financial crisis of 2008, S. 2155, The Economic Growth, Regulatory Relief and Consumer Protection Act, reduces the frequency and thresholds for stress testing and enhanced supervision. In March, in an effort to lessen the confusion surrounding the Basel III high-volatility commercial real estate (HVCRE) rule created for construction loans, the Senate also incorporated provisions from S. 2405, Clarifying Commercial Real Estate Loans, into the larger package of bills included under S. 2155.
The legislation, once signed by the President, will deliver some considerable wins for the CRE market by implementing key clarifications to HVCRE and Acquisition, Development or Construction (ADC) lending requirements. The broader changes designed to better tailor regulatory oversight and the amended CRE provisions could spur new investment and development by easing capital and regulatory requirements, reducing borrowing costs and opening up credit.
CRE borrowers and investors scored a victory earlier this year in February when a Federal Circuit Court lifted risk-retention requirements for commercial loan securitizations. The provisions just passed in The Economic Growth, Regulatory Relief and Consumer Protection Act go a step further in curbing the onerous capital holding requirements imposed in the wake of the 2008 financial crisis.
In addition to changes in capital calculations and exam cycles, for small and mid-sized banks, the legislation includes provisions from H.R. 2148, Clarifying Commercial Real Estate Loans, legislation that passed the House in November 2017, devoted exclusively to CRE considerations, aimed at improving the workability of Basel III and Dodd-Frank Act rules.
The passage of H.R. 2148 followed the release of the Office of Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC) and Federal Reserve’s proposed rule to refine HVCRE requirements, which were first imposed by the Dodd-Frank Act’s codification of Basel III standards. Basel III significantly increased the requirements for HVCRE loans, increasing the risk weighting from 100% to 150% and raising holding requirements from 8% to 12%. Last year’s proposed rule from the OCC, FDIC and Federal Reserve reduced the size of the capital charge from 150% to 130%, but actually expanded the number of loans subject to higher capital charges under the HVCRE definition.
The legislation takes aim at the federal agencies’ interpretation of HVCRE and High Volatility Acquisition, Development or Construction (HVADC) loans and provides some much needed relief and clarity. “The legislation brings welcomed clarification at just the right time,” said Steven Bean, Executive Managing Director, US Advisory and Business Development, at Situs. “The recent proposed rules, while seeking to provide clarify, did not go near as far as the statutory changes that Congress just approved. These relatively minor tweaks to statutory and regulatory HVCRE requirements could go a long way in energizing commercial lending.”
Under current requirements, ADC loans can be exempt from HVCRE statutory requirements only if the loan-to-value (LTV) is 80% or lower, the borrower contributes 15% capital in cash or ‘readily marketable assets’ and the borrower’s 15% capital is contributed prior to lender’s funding.
Under S. 2155, CRE borrowers will be able to fulfill the 15% equity threshold for HVCRE exemption using the appraised value of the property, in lieu of the current cost basis assessment. All loans originated prior to 2015, when the Basel III standards became effective, will be exempt from the need to satisfy HVCRE criteria. The legislation also creates an off-ramp from HVCRE status once an ADC loan reaches maturity.
The original HVCRE requirements in some instances required borrowers to refinance an ADC loan at the end of the risk period. Now, borrowers will be allowed to deploy their own internal capital in an ADC project. Finally, the legislation provides a new exemption for refinancing loans on performing income-generating properties. This provision should ease the restrictions on acquiring and renovating existing rental properties by allowing borrowers to bypass capital penalties. The clarifications to ADC lending will likely have a positive impact across the CRE market, from local communities to small banks and borrowers.
“When coupled with the HVCRE-specific changes, the legislation’s revisions to Dodd-Frank’s stress testing and the easing of capital and regulatory requirements should alleviate a good amount of pressure on banks lending in the commercial real estate space,” said Bean. “The legislation rightly reserves the highest level of supervision for only the largest financial institutions, the positive effects of which will likely ripple throughout multiple financial markets, including commercial lending.”
S. 2155 amends The Dodd-Frank Act to exempt small, mid-size and community banks from some of the most burdensome requirements. Under the legislation, banks with less than $100 billion in assets will no longer be subject to stress testing. Banks with assets between $100 billion and $250 billion may require only periodic stress testing as opposed to an annual review, subject to regulatory approval.
Perhaps most notably, the legislation raises the threshold for enhanced supervision of ”systemically important financial institutions” from $50 billion to $250 billion in assets. Banks with less than $10 billion in assets will be exempt from the Volcker Rule as well. Several provisions are designed to provide targeted relief to community banks, including a simplification of capital calculations and longer exam cycles.
The amended requirements provide CRE borrowers more flexibility to navigate and satisfy HVCRE standards and meet exemption thresholds when possible. The workable requirements and revised supervisory thresholds will also allow more small and mid-size banks to play a greater role in CRE lending.
The illumination of a clear HVCRE definition under Basel III and new federal proposed regulations should reduce borrower costs and expand credit in the area. Most importantly, the impact of S. 2155 should have the combined result of driving new investment, economic development, construction and job growth in communities across the country.