CREFW-Winter2016

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Winter issue 2016 sponsored by CRE Finance World Winter 2016
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the 15% capital requirement, such borrowers will be precluded
from covering the debt service, trade debt and operating costs
of the project.
While many ADC Loans will be structured to include reserves
for interest and other expected expenditures during the period
of construction, developers able to generate capital from, for
example, the sale of pads may prefer to avoid costly reserves and
cover certain operating costs on their own. This prohibition on the
withdrawal of internally generated capital becomes even more
problematic after the project is completed, but not stabilized (and
therefore not yet eligible for permanent financing); the project
may be throwing off enough income to scrape by, but under the
Agencies’ current interpretation of the Final Rule the borrower
is not going to have access to these funds to cover the costs of
operation and ramp up.
Moreover, in a typical construction loan, payment recourse, if any,
burns off upon completion of construction, along with the built in
reserves. At that point, the borrower may be completely reliant on
the project cash flow to cover operating expenses, taxes and the
other items critical to the sound and proper operation of a project.
If not permitted to access that cash flow is the borrower then required
to take another loan or to infuse additional equity notwithstanding
the non-recourse nature of the loan? This flies in the face of today’s
commercial real estate lending practices and it seems unlikely that
sophisticated borrowers will stand for this.
Conclusion
The jury is still out on how ultimately banking organizations will
respond to the new regulatory capital rules embodied in US Basel
III. Some speculate in respect of the HVCRE Rule that regulated
banking organizations will decrease their activity in commercial real
estate lending and that there will be an uptick in the number of
mortgage REITS and private equity funds originating commercial
real estate loans.14
Increasingly commercial banking is a relationship business; many
banking organizations will think long and hard before abandoning
such a significant component of the relationship. That said, those
banking organizations wishing to stay in the commercial real estate
lending business will need to adjust their business models and
expectations of profitability, and in some cases banking organizations
unable or unwilling to suffer lower profitability may be forced to
try and pass the 150% capital charge along to borrowers through
higher interest rates or to get out of the business.
In any event, the more closely aligned the HVCRE Rule can be
made to be with industry realities, the more likely it is that banking
organizations will continue to be able to offer commercial real
estate loan products that are desirable to both the banking
organizations and their customers.
1 Ms. Spyksma works in the Law Department of Wells Fargo Bank, N.A.
as a Capital Markets Counsel.
2 Nothing contained in this paper shall be construed as legal, tax or
accounting advice. The views herein expressed are solely those of the
author and do not necessarily represent or reflect the views of Wells
Fargo Bank, N.A. The author reserves the right to assert positions
contrary to those stated in this paper.
3 78 Fed. Reg. 62181.
4 78 Fed. Reg. 62165.
5 65% in the case of raw land, 75% in the case of land development, for
construction loans, 80% in the case commercial, multifamily and other
non-residential property, and 85% in the case of 1 to 4 family dwellings,
and 85% for already improved land (12 CFR part 34, subpart D; 12 CFR
Part 160, subparts A and B; 12 CFR part 208, appendix C).
6 e.g. the Mortgage Bankers Association, the CRE Finance Council, and
the Real Estate Roundtable.
7 “High Volatility Commercial Real Estate (HVCRE) Exposures”, Frequently
Asked Questions on the Regulatory Capital Rule, Office of the Comptroller
of the Currency, Board of Governors of the Federal Reserve System,
Federal Deposit Insurance Corporation, March 31, 2015.
8 Mortgage Bankers Association’s supplemental letter dated January
26, 2015, addressed to the Comptroller of the Currency, the Board of
Governors of the Federal Reserve and the Federal Deposit Insurance
Corporation, p. 3. Mortgage Bankers Association’s follow-up letter dated
April 1, 2015, addressed to the Comptroller of the Currency, the Board
of Governors of the Federal Reserve and the Federal Deposit Insurance
Corporation, p. 5.
9 Mortgage Bankers Association’s follow-up letter dated April 1, 2015,
addressed to the Comptroller of the Currency, the Board of Governors of the
Federal Reserve and the Federal Deposit Insurance Corporation, p. 4.
10 78 Fed. Reg. 62165
11 Mortgage Bankers Association’s supplemental letter dated January
26, 2015, addressed to the Comptroller of the Currency, the Board of
Governors of the Federal Reserve and the Federal Deposit Insurance
Corporation, pp. 3-4.
12 Mortgage Bankers Association’s follow-up letter dated April 1, 2015,
addressed to the Comptroller of the Currency, the Board of Governors of
the Federal Reserve and the Federal Deposit Insurance Corporation, p. 3.
13 Mortgage Bankers Association’s follow-up letter dated April 1, 2015,
addressed to the Comptroller of the Currency, the Board of Governors
of the Federal Reserve and the Federal Deposit Insurance Corporation,
pp. 3-4.
14 “Banking Regulators to Vote on Basel III Implementation in U.S.”,
Commercial Real Estate Direct Staff Report, July , 2013.
Real Estate Finance in the Era Of Basel III