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BASEL III defines high-volatility commercial real estate transactions

March 21, 2017 Article 2 min read
Brian Franey
Recent guidance from BASEL III evolved to strengthen pre-recessionary lending practices — meaning developers must have more skin in the game. Here's what you need to know.

The regulatory capital rules (BASEL III) that went into effect Jan. 1, 2015 introduced the concept of High-Volatility Commercial Real Estate (HVCRE) — and raised questions among bankers and developers. The guidance defines HVCRE as loans that finance the acquisition, development, or construction (ADC) of real property. The definition excludes loans used to finance one- to four-family residential property, community development projects, or land used for agricultural purposes.

The new rules require all loans that meet the definition of HVCRE to be reported separately from other commercial real estate loans and assigned a risk weighting of 150 percent for risk-based capital purposes. Prior to Jan. 1, 2015, these loans typically would have been assigned a risk weighting of 100 percent.

For call reporting purposes, loans meeting the HVCRE definition are to be reported in Schedule RC-R, Part II, items 4.b and 5.b, and assigned a risk weighting of 150 percent — unless the loan, or a portion of the loan, meets certain criteria that allow for a lesser risk weighing.

ADC loans must meet certain loan-to-value specifications and borrower equity conditions that would exclude them from the HVCRE designation. These are:

  • The borrower is required to contribute equity to the project, defined as cash, unencumbered readily marketable securities, the documented value of the purchase price of the underlying property to be developed (not the appraised value), and documented development out-of-pocket expenses. Any one of these vehicles, or any combination, is acceptable, as long as they total 15 percent of an "as completed" appraisal.
  • The borrower capital contribution is required to be at least 15 percent of the commercial real estate’s appraised “as completed” value.
  • Borrower equity, up to 15 percent, is required to be the first dollars disbursed prior to disbursement of any construction loan funds.
  • The 15 percent equity contribution cannot be layered over future construction draws.The 15 percent capital contribution by the borrower is contractually required to remain in the project throughout the project life. Project life and the HVCRE designation conclude only when the loan is converted to permanent financing, or is paid in full. If the loan is converted to permanent financing, the property should evidence adequate cash flows to service the underlying principal and interest debt service, which conforms to the banks’ loan policy or internal guidance for stabilized properties.
  • The regulatory capital rule does not provide for the grandfathering of existing loans. Therefore, ADC loans made before the effective date of the regulatory capital rule are not exempt from the definition of HVCRE.

If you have questions about the rules or other questions about HVCRE, please give us a call.

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