- The purchase or development of certain agricultural land; and/or

- CRE projects in which loan-to-value does not exceed the applicable maximum supervisory ratio, and the borrower has contributed equity of at least 15% of the appraised “as completed” value. The equity contribution must be maintained throughout the life of the loan.

While the full impact of these rules remains to be seen, it is expected that increased lending costs will be in the range of 40-150 basis points. Since the rules may make it more difficult for regulated lenders to compete with their non-regulated competitors, and costs will be passed along to borrowers, it is a good idea for both lenders and borrowers to understand these exceptions. Until now; however, there have been slight differences in implementation of the rules, leading to confusion in the industry.

Toward Clarity

On April 6, regulators issued a bulletin to summarize their joint approach to frequently asked questions (FAQs). The full guidance document can be accessed here.

Q: Are ADC loans made prior to the effective date of the regulatory capital rule exempted from the HVCRE definition?

No. The rule does not provide for the grandfathering of existing loans, so unless existing loans satisfy criteria for exemption in the definition of HVCRE, they must be treated as HVCRE loans.

Q: Can a loan be reclassified as non-HVCRE if conditions change after it is made – for example if additional collateral is contributed or the value is increased?

No. The determination of HVCRE status is made when the loan is originated. Loans cannot be reclassified as non-HVCRE.

Q: What is the “as-completed” value?

“As completed” is defined by interagency guidelines; e.g. OCC Bulletin 2010-42, and reflects the prospective market value as of the time that development is expected to be completed. Though not specified in the FAQ, the “as completed” is normally calculated by deducting costs to achieve stabilized occupancy from the “as stabilized” value. As such, the as completed value will typical be less than the as stabilized value, though a contact at the Appraisal Institute has indicated that there a unusual situations in which this is not the case.

Q: Can the “as stabilized” value be used for purposes of determining whether the loan is an HVCRE exposure?
No. “Of the three market value scenarios that are generally used by an appraiser (that is, the current [“as is”] market value, the prospective market value “as completed,” and the prospective market value “as stabilized”), a banking organization should consider only the prospective market value “as completed” for purposes of determining whether a project is an HVCRE exposure.” (For new loans, it will be important to make sure that an “as completed” value conclusion is included in the appraisal. For existing loans; however, an appraisal opinion may be required to determine the “as completed” as it would have been concluded at the time the loan was made.)

Q: Is a loan used to purchase a commercial lot considered HVCRE if there is no plan to develop?
Yes - unless the loan is classified as permanent financing in accordance with the lender's normal lending terms or otherwise qualifies as exempt.

Q: Are Small Business Administration (SBA) loans considered community development loans and therefore not subject to the HVCRE rules?
Not automatically. They may be exempt under other criteria in the HCVRE definition, but they are not automatically considered to be community development loans simply by virtue of being sponsored by SBA.

Q: Are Small Business Administration (SBA) 505 loans considered community development loans and therefore not subject to the HVCRE rules?
Not automatically. They may be exempt under other criteria in the HCVRE definition, but they are not automatically considered to be community development loans.

Q: What counts as an equity contribution?
Cash used to buy land or pay development-related expenses may be counted as equity, but should be carefully documented. Payments for interest, engineering costs, governmental fees, reasonable project costs paid to related parties (such as development and management fees, brokerage and leasing commissions - provided the costs are reasonable in comparison to the cost of similar services from third parties) and related pre-development expenses would all be considered equity contributions.

No credit for equity should be considered for a pledge of unrelated real estate, purchase deposits received from possible buyers, proceeds second mortgages or other loans, or grant funding. Funds and securities deposited in an account controlled by the lender would also be excluded from equity contribution unless used to pay project costs to make up the 15% equity prior to the disbursement of loan funds.

The FAQ goes on to address a few additional concerns, but the clarification of HVCRE rules should go a long way toward simplifying the issue for regulated lenders, but some questions remain unanswered:

- Can appreciated land value be counted as equity?
- Do owner-occupied loans count as HVCRE?
- Can the borrower be provided with a “time to cure” equity contributions after funding the loan?
- Cash or securities in a bank-controlled account, letters of credit, etc.

Based on the FAQ, it is possible to speculate as to how these questions would be answered, but I hesitate to prognosticate here. In general, it is expected that the examinations conducted by the agencies will focus on lender philosophies and systems for the classification of ADC loans. Lenders who can provide sound rationale for their approach to these and other unanswered questions should be able to minimize significant criticism, but please feel free to contact me if you would like to share opinions or further discuss these requirements.