May 24, 2018
On Tuesday, May 22, 2018, the U.S. House of Representatives passed the Economic Growth, Regulatory Relief, and Consumer Protection Act (Reform Bill), which had already passed the Senate on a bipartisan basis. President Trump signed the Reform Bill into law today. Among the Reform Bill’s more important provisions is a section reforming the current capital treatment of so-called High Volatility Commercial Real Estate (HVCRE) loans. The Reform Bill, in provisions that are now effective, overrides certain highly conservative provisions in both the federal banking agencies’ (Banking Agencies) Basel III capital rule and their interpretations of it.
Current HVCRE treatment is a purely American phenomenon; it was not included in the international Basel III framework. A form of capital “gold plating,” it imposes a 50% heightened capital treatment on certain commercial real estate loans that are characterized as HVCRE loans.
The current Basel III capital rule defines an HVCRE loan as follows:
A credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances:
Under the current Basel III capital rule, the life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full.
The current Basel III capital rule has raised many interpretative questions; however, many of the important ones have not been answered by the Banking Agencies, and others have been answered in a non-intuitive, unduly conservative manner. In particular, the Banking Agencies interpreted the requirement relating to internally generated capital as foreclosing distributions of such capital even if the amount of capital in the project exceeds 15% of “as completed” value post-distribution. The Banking Agencies also have not permitted appreciated land value to be taken into account for purposes of the borrower’s capital contribution.
The Reform Bill overrides the current Basel III capital rule. Specifically, it states that the Banking Agencies may impose a heightened capital charge on an HVCRE loan (as currently defined) only if the loan is also an HVCRE ADC loan. Such a loan is defined as:
Thus the loan must not only finance or refinance the acquisition, development, or construction of real property, it must “primarily” do so, must have a development purpose, and must be dependent on future income, sales proceeds or refinancing – not current income. The “HVCRE ADC” loan definition also corrects some of the unduly conservative regulatory interpretations described above. It permits appreciated land value, as determined by a qualifying appraisal, to be taken into account for purposes of the 15% test, and it permits capital to be withdrawn as long as the 15% test continues to be met.
In addition, the Reform Bill overrides the current Basel III capital rule by stating that HVCRE status may end prior to the replacement of the ADC loan with permanent financing, upon:
Additional exemptions from HVCRE treatment apply to loans for:
Finally, loans made prior to January 1, 2015 may not be classified as HVCRE loans.
The Reform Bill’s HVCRE ADC provisions are a welcome development. They do not answer every question relating to HVCRE treatment, but they do purge regulatory interpretations that led to heightened capital treatment for many ADC loans in the absence of persuasive risk justifications. It is to be hoped that the Banking Agencies further the legislation’s intent of aligning gold plated capital treatment more closely to risk when interpreting the new law.
 The original version of the Senate bill, which was passed first, did not include this provision. Senator Tom Cotton, R-Ark, proposed the relevant amendment while the Senate was considering the bill.
 The Reform Bill retains the current exemptions for loans financing one- to four-family residential properties, certain community development properties, and the purchase or development of agricultural land.
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and James Springer.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions or Real Estate practice groups, or any of the following:
Real Estate and Finance Groups:
Jesse Sharf – Los Angeles (+1 310-552-8512, firstname.lastname@example.org)
Eric M. Feuerstein – New York (+1 212-351-2323, email@example.com)
Erin Rothfuss – San Francisco (+1 415-393-8218, firstname.lastname@example.org)
Aaron Beim – New York (+1 212-351-2451, email@example.com)
Linda L. Curtis – Los Angeles (+1 213-229-7582, firstname.lastname@example.org)
Drew C. Flowers – Los Angeles (+1 213-229-7885, email@example.com)
Noam I. Haberman – New York (+1 212-351-2318, firstname.lastname@example.org)
Victoria Shusterman – New York (+1 212-351-5386, email@example.com)
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