From HVCRE to HVADC: Simplification Doesn’t Equate to Improvement
By Chris McHenry, Seedcopa Senior Portfolio and Compliance Manager
Some potentially frightening evolutions have occurred due to the replacement of HVCRE regulations with HVADC regulations, and lenders have been asking us how to navigate them.
The main concerns under the changing regulations: How does a lender that has been incubating a small business, or calling on a growing company, remain competitively priced while still financing real estate to the greatest extent possible? How does that lender help to preserve the working capital necessary to finance the business’ growth?
The move from the existing HVCRE rules to the HVADC definition is being hailed by regulators as a positive step toward simplifying and reducing some of the Tier 1 capital burden on banks. But as with many regulatory changes, this adjustment is not necessarily a positive one. While the Capital weighting under BASEL III is being dropped from 150 percent to 130 percent, the 15 percent capital contribution exemption is being eliminated. The result: Many more loans will be classified under the HVADC guidelines as HVCRE credits. This makes it difficult for lenders to price competitively and borrowers to fund their projects adequately.
Further, the new HVADC rule more clearly defines an exempt permanent loan. The loan must meet two significant criteria to be considered a permanent loan exempt from HVCRE status under HVADC. First, the permanent loan is defined as a loan that is “prudently underwritten,” generating yet another grey area open for interpretation and exploitation by the various regulatory bodies. The second significant requirement is that a compliant permanent loan must be a loan where a borrower has an “ongoing” source of repayment other than sale of the property. “Ongoing” is being interpreted and defined as “existing” and “continuing.” Therefore, the definition itself places a punitive burden on institutions financing expanding and start-up small businesses. This will likely force an increase in loan pricing or decrease in loan-to-value.
One of the positive changes that has been wrapped into the HVADC final rule is an exemption for bridge loans extended as part of an SBA 504 Loan. The result: With SBA funding the balance of the transaction above 50 percent, a lender has now reduced the bank’s permanent LTV to a point below the HVCRE/HVADC target and has a hard exemption in place for the interim loan funded to facilitate the 504 loan funding.
From a borrower’s perspective, this is a very desirable option. The 504 interest rates are fully fixed below the current market rates (4.6 percent in January 2018), are self-amortizing over 20 years (a 25-year option is coming later this year), and can finance up to 90 percent of a project with LTVs approaching 100 percent.
SBA 504 funding allows lenders to finance HVADC real estate at competitive rates while avoiding the 130 reserve weighting under BASEL III. Borrowers benefit by preserving capital as a result of the decreased equity contributions and securing a long-term, low fixed rate. In the face of HVADC, lenders who utilize the benefits of SBA’s 504 program for their clients provide a substantial benefit for their borrowers and their bank.
Chris McHenry is a Senior Portfolio and Compliance Manager for Seedcopa, your government loan specialist in Pennsylvania. Together with its affiliate, the Chester County Economic Development Council, Seedcopa helps to grow local businesses, create and retain jobs, and stimulate local communities.
For over thirty years, Seedcopa has helped businesses get the money they need to start, grow and expand. We are proud that the loan programs we work with promote economic development.
Together with economic development partners throughout Pennsylvania, we help to grow local businesses, create and retain jobs and stimulate local communities.
Our team has over 75 years of combined government lending experience and a dedication to excellent customer service. After our initial assessment of your project, our commitment is to get you approved and closed.