Proposed Legislation May Boost Construction Financing

In Tannenbaum Helpern’s Note from the Real Estate Group distributed in early 2017 titled “An Eye on Commercial Real Estate in 2017”, we highlighted a few potential changes in 2017 which could have a material impact on the commercial real estate market. One of the potential changes we highlighted was the withdrawal of the United States from implementing the Basel III Accord, thereby allowing banking institutions to avoid the increased capital reserve requirements under the Accord in connection with making construction loans.

Although the United States has not withdrawn from the Basel III Accord to date, on November 7, 2017, the House of Representatives passed a bill known as the Clarifying Commercial Real Estate Loan Act (H.R. 2148). This bill, if passed into law, will provide banking institutions with increased certainty and comfort in making construction loans, without triggering the increased capital requirements under the Basel III Accord; and thereby, potentially spurring available construction financing.

H.R. 2148, which drew broad bipartisan support, aims to reduce the impediment to construction lending under the Basel III banking restrictions. Under Basel III, banking institutions are required to maintain additional capital with respect to all high volatility commercial real estate (“HVCRE”) loans, due to the added inherent risk with such loans. Under existing regulations, adopted by the Federal Reserve and Office of the Comptroller of the Currency in 2015, it has been ambiguous as to what qualified as HVCRE loans, and banking institutions (being cautious) have been compelled to take the position that most construction loans are HVCRE loans and are subject to the increased capital retention requirements under Basel III. Accordingly, banking institutions have limited their construction lending activities and/or attempted to place the increased cost of such capital retention on their borrowers. With the resulting increase in borrowing costs from these banks, developers have more often turned to lenders who are not subject to the Basel III capital retention requirements for construction financing, such as foreign lenders, private equity funds and debt opportunity funds.

H.R. 2148 addresses the ambiguity by codifying and clarifying which loans constitute HVCRE loans, and which loans are exempt from such characterization. In addition, although the bill does not eliminate the regulatory agency’s ability to require banks to retain higher capital levels for HVCRE loans, the bill does further limit the types of loans that qualify as HVCRE loans. With respect to loans that are subject to HVCRE regulations, the bill broadens the types of bank equity that can be used to meet the bank’s capital requirements and provides a framework for loans to exit HVCRE status.

Proponents of the bill include the Mortgage Bankers Association, the Real Estate Roundtable and the Commercial Real Estate Finance Council. Supporters have argued that the bill could spur more construction lending, as banks will no longer be deterred by the increased costs of additional capital requirements for HVCRE loans. In addition, bank construction lending would become more competitive with non-bank lenders, as the playing field between banks and non-bank lenders would be leveled. Although passage of H.R. 2148 in the Senate would not be a repudiation of the Basel III Accord that many had hypothesized going into 2017, the bill’s passage could be a welcome benefit to banks, as well as to borrowers seeking additional options for construction financing.

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12.14.2017  |  PUBLICATION: Note From The Real Estate Group  |  TOPICS: Real Estate  |  INDUSTRIES: Real Estate

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