It’s 2019 – Take Courage!

It’s 2019. Nothing really terrible or shocking has happened yet…at least by the standards of December. But it’s early yet. As a card-carrying member of the commentariat, I could not possibly pass up the opportunity to bloviate on the “Year Ahead” with the certain knowledge that no one will remember if I’m wrong, and if I’m right, I’ve got bragging rights! The temptation of course is to go full Nostradamus and say things like, “The path of the market will continue to repudiate and embrace the past and the Fed shall, at last, flom the gabberwobber!” Being Nostradamus is never having to say you’re sorry.

In the spirit of CrunchedCredit, which purports to be firmly rooted in the real world of capital formation, commercial real estate and markets, we feel more than a skosh of pressure to try to be a tad more prescriptive and to stick to things that might be useful for those trying to do stuff. However, seriousness of purpose and a bit of thoughtfulness should not be confused with any real likelihood of being right.

With all that said, here’s what CrunchedCredit thinks about 2019:

Hunkered Down Investors. The investor class largely hung it up late in Q4 this past year and we are all nervously awaiting their return. Like that pesky groundhog in Pennsylvania, they’ve got to show up! I am committed to a strategy of hope that the investors will return in early 2019 and embrace risk. We should know pretty soon after this is published whether those shy and anxious investors will poke their noses out of their dens. If not, it could be a rough year. If they do come out, don’t dismiss the possibility that they scurry back into their dens at the first whiff of powder.
US Domestic Politics. The cage wrestling in the swamp magnified by our sad headline machine will continue to cause gyrations in, at least, equity markets which seem particularly flighty. Is the problem spooked individual investors or are the equity markets now slaved to the dues ex machina of AI programs with algorithms tied to social media, Twitter feed and the news cycle written by a tattooed millennial with the social skills of a three-day dead carp and zero understanding or interest in the real economy or economic fundamentals? Saul of Tarsus may have found God on the way to Damascus two thousand years ago, so anything is possible I guess, but it’s hard to conceive of anything coming out of the US domestic political scene that would improve the economic environment or investor confidence. If we’re going to have a good year, we’ll all just have to ignore the noise.
Ditto Geopolitical Events. Brexit might not be awful but it certainly is not going to be good. Western Europe continues to get weirder and weirder as the tide of political small “l” liberalism continues to recede. As we have observed in this commentary before, absent some remarkable political rapprochement amongst the major players, the question is not whether the European Union survives in its current form, but when it fails. The Euro is, eventually, toast. While Western Europe is always the hands down winner of the Kick-the-Can-Down-the-Road Award, there will be a bridge too far someday soon and the center will not hold. We trust that it is not this year. Revanchist China and Russia are just plain bad news. The ambitions of Russia and China on the world stage during periods of their rapid economic growth may not have been great, but those two bad boys on the world stage in a period of economic financial distress at home is even more frightening.
Regulatory Burden. The regulatory burden here in the states is somewhat abated from the “if it moves (or certainly makes a profit), regulate it” heyday of the Obama administration. Moreover, our friends at Basel seem to be quiet at the moment and regulatory initiatives such as the Fundamental Review of the Trading Book and other capital raising regulatory regimes seem to be on a pause for at least as long as the European economic machine continues to stutter. Here at home, the incurred loss methodology of recognizing credit losses might have another day in the sun as the quietly criticized and broadly loathed CECL model (thank you, FASB) looks like it may also be on pause for a while longer. Capping it off, we may get good news on HVCRE , Volcker , etc.
Heads I Win, Tails You Lose. There’s a real chance that either interest rates begin to retrace their upward path downward because the economy sucks, or both the short and long end of the curve start to move upward without a concomitant refreshing of economic growth because of inflation and stagnant productivity. In both cases, the economy will contract and the cost or availability of debt will begin to stress businesses in the real economy and imperil capital formation in the commercial real estate space. Have faith in the Fed?
The Fed Behaving Badly? Speaking of the Fed, we’re fascinated with the Fed these days. It’s not like we haven’t had a Fed for ages. Nor is it that the Fed didn’t have the same tools in the toolbox, nor the same dual mandate to both protect the value of our currency and insure full employment for decades. What’s different? The media has turned the Fed into a rock star (presumably, however, without the fun of booze, drugs, roadies and wild parties). It’s the shiny thing that we can’t bear to look away from. That fascination keeps moving markets and creates volatility. This would maybe make sense if the Fed were rightly and widely known for its infallibility. However, if they have a secret Rosetta Stone which supports perfect, predictive forecasts, it’s about time they pull it out and start using it, isn’t it? So, it’s likely the Fed will over or undershoot as the Fed attempts a soft landing here. And that’s okay, it happens all the time. A quiet “Oops” is muttered and we adjust. If you’re rooting around for something special to worry about (it’s different this time), it’s the Fed’s balance sheet and its current “autopilot” reductions. If increasing the Fed balance sheet from $1 trillion to $4+ trillion during the Great Recession gets credit for stabilizing the economy and militating against a more significant economic crisis, then shouldn’t we think that shrinking the balance sheet might have a significant economic impact as well? Who knew? We’re in the “Here Be Dragons” part of the economic treasure map and I’ll guess we’ll find out.
Entropy. All systems degrade, whether that’s the sun lit uplands of the 2010-18 expansion here in the US, or simply the larger arc of the end of history fantasy born in the late 1990s. Things that work break; systems degrade. It’s been good for a long time. Moreover, as the world gets more complex, interconnected and technologically dependent, it seems to us less rugged and more susceptible to the knock-on consequences of bad things happening. Our economy is a brilliant construct delivering high octane economic performance, but fundamentally pretty fragile. Stone cairns survive from the time of the ancients while beautiful glass vessels shatter. Don’t we feel a little glass vessel-ish to you?

So taking all that on board, I want to announce that It’s Going To Be Okay. It’s fine. And you thought this was going to be another one of those morose, zombie apocalypse type of things that I periodically pen. Nope, not this time.

I mean it’s easy to wring ones’ hands and there’s always something riveting about a train wreck (as long as you’re not on the train…are we?), and all those bad things could happen and could upset Goldilocks. But, take a deep breath, folks. There’s still good news out there. GDP growth has been strong. The real economy has so far shaken off the noise of the stock market. Even the fiddling stock market has roared back this past two weeks. There’s been a number of business-friendly changes in tax and regulatory policy over the past couple of years, and certainly there’s a more business-friendly environment inside the federal judiciary. Trade policy? Well, it could end up okay…right? The banks are stronger. (I hesitate to use the phrase “fortress balance sheet” only because the Europeans do so without any sense of irony.) We’ve got a relatively amiable interest rate environment and significant consumer confidence without overwhelming consumer debt. The corporate debt situation is benign and while government debt is going through the roof, no one seems to care…at least for now. What’s the likelihood of exogenous shocks? None of the geopolitical players, either at home or abroad, presumably are actually intent on blowing up the world. Let’s face it, we’re all pretty good at kicking the can down the road. So while big ticket macro and geopolitical risks abound, odds are that really bad things won’t happen and the economy will continue to grow, albeit at somewhat more muted levels for 2019 and perhaps more years after that.

Let’s talk recession. Here’s the shocking headline: We’re going to have a recession at some time. Put on the big boy and big girl pants and face up to that. There’s nothing wrong with a recession. After 10 years of this expansion, we’ve lost perspective. A recession is not the end of the world. They happen periodically. Always have. Always will. And from the burning embers of every recession a new expansion is born. Like the old adage about generals fighting the last war, when we think recessions these days, we see the Great Recession of 2007-2009, which would indeed suck. But, do we really think that’s the template of the next downturn? Seems to me the next one will be more like the preceding four or five relatively short, intense V-shaped recessions that have characterized the American economy since World War II. It’s just not the end of the world. (Trust me, if you’re a banker and have never seen a recession, and maybe that’s most of you these days, it’s really not all that bad.) If it doesn’t happen in 2019, it’s going to happen in 2020, 2021 or 2022. It’s going to happen. When it occurs, it’ll present everyone in the business community with challenges, but challenges that we have regularly met in the past and will meet this time as well.

So here’s to a good 2019. It might be the last year of this expansion, but maybe not. Someday soon we’ll have to deal with a recession. Not today. Investors are coming out of their Q4 dens, capital formation will continue, the economy will continue to grow, commercial real estate will continue to function reasonably well and the Bad News Bears will tut-tut while continuing to invest and we’ll all have a bloody good time. Enjoy it. It will end, but not yet. So there.

Ignoring Macro…Or Are We as Smart as a Horse?

By Rick Jones on December 20, 2018 Posted in Credit Crisis, International Economies

My, my, what a couple of weeks. People, don’t you understand that I’m trying to run a business here? Is a recession on the doorstep or is that a 2022 thing? Are things really bad, or really good? How am I supposed to stay dispassionate and analytic when the stock market gyrates and the drumbeat of portentous news never stops? The worst December in the market since the Depression says The Financial Times! It’s very annoying and I feel very much put upon.

All of this has got me thinking, are we ignoring Macro? Are we not seeing what’s actually in front of us? Not seeing the Big Stuff? There is surely enough disturbing things out there to get and hold our attention. The stock market continues to oscillate widely, the 10-year Treasury Rate is now well below 3%, volume is up and every time another headline crosses the ticker, everything changes again. Is our trade dispute with China existential? Is Prime Minister May in or out – happy or sad? Is Boris Johnson having a good hair day? The Italians are leaping around and gesticulating broadly, outraged now about how France may be getting a pass on budget discipline. If France starts to cheat (again), can the center hold? Japan is building an aircraft carrier…think about it. In China, some young general suggested it might be a good idea to shoot at an American warship in international waters. There’s a great idea. The Donald continues to tweet and we almost had a smack down in the oval office between the President, Nancy Pelosi and Chuck Schumer just last week. Continue Reading

The CRE CLO Is Back…and That’s Good

By Rick Jones on December 5, 2018 Posted in CMBS, Commercial Mortgage Finance, Commercial Real Estate, Real Estate, Securitization

We have been writing off and on about the restoration to good graces of the commercial real estate CLO since the early days of this current recovery, and it’s important to keep the conversation going. Hey, if Pete Rose can get into the Hall of Fame (and as MLB is embracing gambling, that cannot but happen, right?), the full restoration of the reputation of the CRE CLO cannot be far behind.

First, let’s just stop and get some definitional clarity here for those of you who actually have a life. Fundamentally, the CRE CLO is a device that provides match-term leverage for a portfolio lender, though the technology can be used for other purposes. Loans are pooled, investment-grade securities are sold to investors, and the loans are repaid from debt service payments. Customarily, the sponsor retains all of the equity and junior debt, creating structural leverage to enhance returns on the dollars invested in the structure.

It’s really a warehouse funded by the capital markets. As such, it provides for an excellent alignment of interests between investors and the sponsor, who holds the bottom of the capital stack. The sponsor is in it for the long haul, managing financial assets for its benefit and the benefit of the investors alike. Continue Reading

2018 Golden Turkey Awards

By Rick Jones on November 19, 2018 Posted in Awards, Brexit, Commercial Real Estate, Europe, Golden Turkey Awards, HVCRE, Regulatory, United Kingdom

It’s that time again for Dechert’s CrunchedCredit Annual Golden Turkey Awards. In a year made most remarkable by the extraordinary performance of the US economy, idiocy, silliness, pigheadedness and stupidity have tended to be somewhat obscured by the economic good news machine. At the other end of the spectrum, the continued high volume of outrage over almost everything from both the left and right (and I’m sure the middle would do their fair share here if there was anyone at home) makes it harder to suss out the truly memorable and award-winning, but it’s our job to try. As we have said in the past, this would be really hard if the world actually behaved in a predictable, rational, Newtonian universe sort of way, but blessedly it does not.

Do I Have to Talk About Brexit?

By Rick Jones on November 1, 2018 Posted in Brexit, International Economies, United Kingdom

We haven’t written much about Brexit…largely because, for the life of me, I have been unable to embrace, with any conviction, a view as to whether the Europeans will dodge this bullet, as they have dodged so many in the past, or whether chaos will finally ensue. Then, if chaos ensues, I’m equally clueless about what the contours of the chaos will be; what a hard Brexit will look like. I am baffled. And while it is demonstrably true that cluelessness and bloviation are not mutually exclusive, I, perhaps more thin-skinned than most of the chattering class, have been waiting for some sort of an epiphany before I wrote on the topic.

But birds gotta fly, fish gotta swim and us members in good standing of the commentariat gotta prattle on. Since I’m not convinced I’m going to get any smarter and since this is likely to be one of the seminal economic events of 2019. I’m diving in. Might be ugly. Hide the children.

The Next Recession: Something…Perhaps Not Really Wicked… But Certainly Annoying…This Way Comes

By Rick Jones on October 15, 2018 Posted in International Economies, Real Estate, Regulatory, Securitization, Structured Finance

With full and complete credit to the Bard (Macbeth), and to Mr. Ray Bradbury who repurposed this line as the title for his 1962 dark fantasy (of which I was and still am a huge fan), there is just not a better title for this note. Trust me. A few weeks ago, I inked a note about whether the current expansion was soon coming to an end and whether it made sense to begin to “get the distressed debt band back together again.” Tongue slightly in cheek then because things seemed awfully good, I made the argument that we are not really all that far away from an abrupt right turn off the highway of good times onto the dirt road of distress. It apparently resonated (or at least there’s lots of people who think like me). Dechert is hosting a distressed debt conference on October 18, 2018 in New York which will touch on a wider range of issues but will include a distressed debt panel and we now have almost 400 RSVPs. We’ll report on that next week. That’s either 400 people with nothing better to do, or 400 folks who think it might just as well be time to start thinking about the end of days. Continue Reading

IMN 2018 ABS East Conference

By Linda Bartosch on October 4, 2018 Posted in Seminars and Conferences

Last week, an estimated gathering of over 4,700 of the industry’s finest descended on Miami for IMN’s ABS East conference. The mood was upbeat and the meeting rooms (and the lobby bar) were crowded, as participants raced to fit in as many meetings as possible. If there was one overall takeaway from the conference, it was that there is a lot of money looking to invest in the ABS sector, which continues to enjoy strong fundamentals and a hearty appetite for deal making. We are excited to see all the term sheets that come out of this conference and help get some of those deals closed. Continue Reading

Proposed Rule Regarding HVCRE ADC Open for Comment

By Krystyna Blakeslee and Gina Leahey on September 28, 2018 Posted in HVCRE, Regulatory, Regulatory Complexity

Are you ready? The proposed rule regarding HVCRE ADC has been published in the Federal Register today and is open for comment. You know the drill, comments are due in 60 days (by November 27, 2018). Give us a ring for more background on HVCRE ADC and the proposed rule. We’re always happy to discuss the questions posed by the regulators and consider potential responses. And be sure to check in to Crunched Credit in the coming weeks as we do a deep dive into the whole new world of HVCRE ADC as a result of the recent amendment.

Are you there FDIC, OCC and Fed Res? It’s us, Crunched Credit: Regulators Request Feedback on HVCRE ADC

By Krystyna Blakeslee and Gina Leahey on September 25, 2018 Posted in HVCRE, Regulatory, Regulatory Complexity

On September 18, 2018, the Federal Reserve, FDIC and OCC released a Notice of Proposed Rulemaking (NPR) regarding HVCRE. The good news is that the stated intent is not to alter any of the improvements made by EGRRCPA , instead the agencies describe the proposed rulemaking as conforming the regulatory capital rule to the new statutory definition of HVCRE ADC and providing interpretations of certain terms consistent with their usage in other regulations. This is good news indeed. We were somewhat concerned that the regulatory state in full might try to steal some back here, but they seem to have gotten the message.

There are a few immediate takeaways from the NPR – namely, HVADC is dead and that the test for whether a loan qualifies as an HVCRE ADC exposure occurs only once – at origination. So, after origination, you can fall out of HVCRE ADC (with the new reclassification provisions) but you can’t fall into HVCRE ADC.

Embracing hubris, perhaps, we’d like to think the agencies are readers of Crunched Credit. They certainly address many of the provisions we highlighted in our prior commentary. Here are some of the highlights:

Crunched Credit: What does “primarily finances” mean?
NPR: The agencies request comment on whether the term[] … “primarily finances,” … [is] clear or whether further discussion or interpretation would be needed.

Crunched Credit: When is development “substantially” complete?
NPR: The agencies invite comment on whether [substantial completion of construction] is ambiguous or needs interpretation? The agencies invite comment on what, if any, operational challenges would banking organizations generally expect when determining whether an HVCRE exposure under the proposed revised definition can be reclassified as a non-HVCRE exposure?

Crunched Credit: What is the “cash flow” test?
NPR: The agencies invite comment on what, if any, operational challenges would banking organizations generally expect when determining whether an HVCRE exposure under the proposed revised definition can be reclassified as a non-HVCRE exposure?

Crunched Credit: It’s clear that HVCRE ADC supersedes the old rule for loans made after May 24, 2018 (and provides grandfathering for loans made prior to January 1, 2015), but it’s unclear what it does to loans made from January 1, 2015 – May 24, 2018. Are these loans now subject to HVCRE ADC for re-classification? We would like for clarity (although maybe we already have it) that the new HVCRE ADC applies to those loans as well.
NPR: For ADC exposures issued on or after January 1, 2015, banking organizations would follow the interagency statement that permits them to either apply the statute on a best efforts basis or classify HVCRE ADC exposures according to the superseded definition until the final rule is effective. The agencies invite comment as to whether the final rule should require reevaluation of ADC loans originated on or after January 1, 2015 under the revised HVCRE exposure definition. What are the advantages and disadvantages of requiring reevaluation? What alternative treatments, if any, should the agencies consider?

Crunched Credit: Can mezzanine debt and preferred equity count for the 15% Borrower equity contribution test?
NPR: The agencies invite comment on whether their proposed interpretation of the 15 percent contributed capital exclusion is appropriate and clear or whether further discussion or interpretation would be appropriate. What other issues, if any, relating to the contributed capital exclusion require interpretation?

Well, glad you asked! As with the last rodeo, the public will have 60 days from the date the rule is published in the Federal Register to comment. It has not been published yet, but rest assured readers, we are watching the FedReg for it and will post an update once the comment period begins.

Review our archive of commentary for more background on HVCRE ADC and EGRRCPA. Better yet – we make house calls! We would be happy to do a teach-in or host a Q&A session on the changes. Please let us know if that would be helpful and we’d be happy to set up a time! And- stay tuned for further commentary as we digest the posed questions and consider potential responses.

HVCRE (The Reformed Loan): Musings and Next Steps

By Krystyna Blakeslee and Gina Leahey on September 17, 2018 Posted in HVCRE, Real Estate

Since my last post, the Economic Growth, Regulatory Relief, and Consumer Protection Act (which some are referring to as EGRRCPA – oof.) was signed into law by President Trump on May 24th. Section 214, titled, “Promoting Construction and Development on Main Street,” amends the Federal Deposit Insurance Act to clarify what loans are subject to HVCRE, when loans are measured for HVCRE exposure and what we call loans subject to HVCRE (spoiler alert: it’s not HVCRE!). Long story short, despite all the grumblings about this reform, Dodd-Frank has not gone the way of the Dodo. Here’s what we know, what we think we know and what we think you may be able to do.

What We Know

(For loans made after May 24^th) HVADC is out – HVCRE ADC is in.

Under Public Law 115-174, regulators “may only require a depository institution to assign a heightened risk weight to a high volatility commercial real estate (HVCRE) exposure (as defined in 12 C.F.R. 324.2 ) under any risk-based capital requirement if such exposure is an HVCRE ADC loan”. So, after all the back and forth with HVCRE and HVADC , it is finally settled: only those loans classified as “HVCRE ADC” can be subject to HVCRE. Wait, what?? (We hope this means that the regulators will abandon HVADC…).

So, what is an HVCRE ADC loan? An HVCRE ADC loan is a credit facility secured by land or improved real property that (A) primarily finances, has financed, or refinances the acquisition, development, or construction of real property; (B) has the purpose of providing financing to acquire, develop, or improve such real property into income-producing real property; and (C) is dependent upon future income or sales proceeds from, or refinancing of, such real property for the repayment of such credit facility.

Let’s start with the good: thankfully, the revised definition clarifies that only credit facilities secured by land or improved real property are subject to HVCRE ADC. One addition to the definition from the prior incarnation is that an HVCRE ADC loan “primarily finances” acquisition, development or construction. We have no idea what “primarily finances” means – 50%, 60%, 95%? But – maybe this ambiguity is good. Should we be racing to the regulators to fill in all of the “grey”? If we do that, we have no room to make calculated and reasonable decisions (that are good for the bank and the borrower) and ask forgiveness (if it ever comes to that!) later.

Another new addition to HVCRE ADC is the requirement that the loan “has the purpose” of providing financing for ADC. Again – what does this even mean? We are in new territory with the regulators being concerned about the “purpose” of a loan. How do you even figure this out? “Purpose” seems to be in the eye of the beholder. And, when is the “purpose” decided? At origination? Hopefully! Banks should not be required to continuously monitor the borrowers’ use of funds in order to be technically compliant.

We’re not thrilled that unimproved land (without any construction or development component) still falls under HVCRE ADC, especially where the loans are fully guaranteed (how much sense does that make?).

Further, we worry that now that any loan that “has financed” the acquisition, development or construction of real property could potentially fall under HVCRE ADC, does that mean that a loan made after January 1, 2015, that, “had financed” the acquisition of real property but wasn’t previously subject to HVCRE now would be? Practically, probably not, but well worth the thought exercise (at least to us dorky lawyers).

HVCRE ADC loans are not:
- Loans that are secured by one- to four-family residential properties, real property that would qualify as an investment in community development or agricultural land;
- Loans to acquire, refinance or make improvements to existing income-producing properties with cash flow generated by the real property that can support its debt service and expenses (in accordance with the bank’s underwriting criteria for permanent financings);
- Commercial loans with (i) an LTV less than or equal to current standards as determined by the regulators, (ii) a borrower contribution (in cash, marketable assets, out-of-pocket development expenses or real property and improvements) of at least 15% of the appraised “as completed” value and (iii) such contribution was made prior to any advance under the credit facility (and such contribution is required to remain in the project until the loan is reclassified as non-HVCRE ADC); and
- Loans made prior to January 1, 2015.

It’s now clear (at least as clear as these things get) that ground-up construction is HVCRE ADC (Yup – makes sense…risky lending deserves some regulation) and already improved property (that IS cash flowing sufficiently to pay debt service and expense) is NOT HVCRE ADC. And that’s where banks find themselves with a lot more breathing room: now, the “construction-lite” loans where the property is improved, cash flowing and the loan is being made to finance some sort of renovation, face list or tenant improvements may NOT be HVCRE ADC (depends).

The above exemptions are substantially similar to the original HVCRE regime (so repurchase facilities and loan on loans are exempt, as is mezzanine debt secured by borrower equity with ADC), with a few important tweaks: first, the calculation of what counts as Borrower equity contributions is different and second, the div stopper is less onerous.

As we all know, to be exempt from HVCRE ADC, Borrower must have 15% equity in the deal. The equity contributed can come in the form of cash, development costs spent at the property, and the value of the land (based on a current appraisal). Note, under the old HVCRE regime, the value of the property was determined at acquisition, so no appreciation benefit was given. Now, the appraisal will be based on the “as completed” value of the property (so borrowers can get the benefit of an appreciation in land value making holding onto real property well worth it!).

In addition, under the new HVCRE ADC rules, if the property starts cash flowing, the cash can be distributed to the borrower’s equity holders so long as the 15% contributed capital described above stays in. Whereas under the old regime, no money could be leaked out during the life of the loan. Hooray! Gotta celebrate each victory!

Loans that are made under the HVCRE ADC regime can be “reclassified” as a Non-HVCRE ADC loans.

Probably the biggest breakthrough in the reform is the ability to reclassify loans. This allows banks to reduce their capital stack once the loan is stabilized. Under the new regime, a loan can be converted to a “Non-HVCRE ADC Loan”:

Upon the substantial completion of the development or construction; or
Once the property generates enough cash flow to support the debt service and expenses in accordance with the bank’s underwriting criteria for permanent financings.

Going forward, loan documents for HVCRE ADC loans should build in mechanics (or not- the language seems to suggest the bank can reclassify on its own but borrowers may want some certainty built in) for reclassification (e.g., upon substantial completion, satisfaction of a DY/DSCR test, etc.) as this would remove the div stopper and allow internally generated cash flow (above the 15% required capital contribution) to be dispersed (mezzanine lenders rejoice!). We would expect to see, at a minimum, a spread step-down in the interest rate too…maybe? There are other ways too we can think of to handle the “cash flow” test which we will be discussing with our clients.

Giving borrower’s greater optionality may be one way to make “Main Street” like banks again.

What We DON’T KNOW

The Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation issued a statement on July 6, 2018 , clarifying that banks “may refine [estimates regarding HVCRE ADC loans] in good faith as they obtain additional information but will not be required to amend previously filed regulatory reports as these estimates are adjusted.” In addition, the agencies gave banks the option to continue to report and risk-weight HVCRE exposures in a manner consistent with the current instructions, until the agencies take further action. The agencies also indicated that they plan to promulgate regulatory revisions in the future. In response, Representative Pittenger and others sent a letter to the agencies on August 1^st, thanking them for their assurances that the agencies will work to conform the existing regulations to EGRRCPA.

We too are jazzed up about the promised regulations. We’d like to see (at a minimum) the following addressed (or maybe we don’t…are we better off with ambiguity so then we can ask for forgiveness later?):

What does “primarily finances” mean?
When does a loan “ha[ve] the purpose” of providing financing for ADC?
When is development “substantially” complete?
What is the “cash flow” test?
It’s clear that HVCRE ADC supersedes the old rule for loans made after May 24, 2018 (and provides grandfathering for loans made prior to January 1, 2015), but it’s unclear what it does to loans made from January 1, 2015 – May 24, 2018. Are these loans now subject to HVCRE ADC for re-classification? We would like for clarity (although maybe we already have it) that the new HVCRE ADC applies to those loans as well.
Can mezzanine debt and preferred equity count for the 15% Borrower equity contribution test?

Check back in the coming weeks as we discuss the above and consider whether the FAQs apply to HVCRE ADC and the fate of HVADC. The forthcoming regulations, coupled with how banks adapt to HVCRE ADC will determine whether we finally got the major HVCRE reform we’ve been looking for or if EGRRCPA failed to move the needle. In the meantime, we will be sitting here musing over the new HVCRE ADC legislation, thinking of creative solutions to a problem someone has got to have. Give us a ring. Let’s see what we can make stick!