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Ahead of reforms, HVCRE falls further in Q2'17

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Ahead of reforms, HVCRE falls further in Q2'17

Regulators have proposed a replacement to the high-volatility commercial real estate designation, potentially adding more credits subject to higher risk-weightings.

The high-volatility commercial real estate, or HVCRE, classification was introduced under the Basel III capital regime and captures certain loans made to fund the acquisition, development or construction, or ADC, of commercial real estate. Regulators viewed those credits as riskier, assigning a 150% risk-weighting value to HVCRE, well above the 100% weighting under the general risk-based rules.

Relaxed treatment for these loans, among other measures, has recently been proposed by regulators, a positive development for the industry, which has long-criticized the HVCRE designation as overly complex and unduly burdensome.

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According to the proposed rules, the HVCRE classification for banks under the standardized approach would be replaced with a simplified evaluation to determine whether a credit is an HVADC, or high-volatility acquisition, development or construction exposure.

The HVADC classification would apply to a credit facility if more than 50% of the loan proceeds are used for ADC activities and would only apply to exposures originated on or after the final rule's effective date.

Notably, the proposed HVADC definition eliminates HVCRE's capital contribution exemption. HVADC retains HVCRE's exemption for one- to four-family residential properties as well as the purchase or development of agricultural land. The definition also broadens the existing exemption for community development loans.

An additional exemption is provided for "permanent loans," defined as a prudently underwritten loan that has a clearly identified ongoing source of repayment sufficient to service amortizing principal and interest payments aside from the sale of the property.

As a result of the broadened definition, it is likely that more ADC under the proposed rules could be classified as HVADC. The associated risk-weight, however, would be lower, at 130%.

In April, U.S. Rep. Robert Pittenger, R-N.C., introduced legislation that would provide a strict legal definition for HVCRE loans as well as clarify when HVCRE loans may exit the designation. The measure has received bipartisan support and is set for mark-up, although its prospects beyond the House Financial Services Committee are unclear.

The banking industry's total balance of HVCRE loans continued to drop over the second quarter of the year. Total HVCRE stood at $113.46 billion as of June 30, marking a 2% quarter-over-quarter decline and a 3.8% decline from peak levels recorded at the end of 2016.

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Click here to view a refreshable template that displays the risk-weighted assets of a bank under the final Basel III rules.

Banks and thrifts report capital information on call report schedule RC-R, which can be accessed under the Regulatory Financials section of a company's briefing book page on the SNL website or in SNL Office.