High-Volatility Commercial Real Estate Loans:

Guidance for Developers and Lenders on

HVCRE Rules and Loan CovenantsNavigating Borrower Contributed Capital Rules, Maximum LTV Ratio, Conversion to Permanent Financing and More

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WEDNESDAY, SEPTEMBER 5, 2018

Presenting a 90-minute encore presentation

Joseph Philip Forte, Partner, Sullivan & Worcester, New York

Matthew (Matt) Galligan, President, Real Estate Finance, CIT, New York

Gregg Gerken, Executive Vice President, U.S. Head of CRE, TD Bank, New York

William G. Lashbrook, Senior Vice President, PNC Bank, Pittsburgh

{N0528626; 1}

The Impact of the New Clarifying CRE Loans Legislation on the HVCRE Rule

by Joseph Philip Forte

The recent financial deregulation legislation (S. 2155) passed by the House of Representatives

(258-159) on May 22, and which was previously passed by the Senate in March and signed into

law by the President on May 24, includes significant reforms to the Basel III High Volatility

Commercial Real Estate (HVCRE) Rule and the proposed HVADC Rule.

The bipartisan HVCRE measure originally was co-sponsored by House Financial Services

Committee members Robert Pittenger (R-NC) and David Scott (D-GA) as the Clarifying

Commercial Real Estate Loans bill (H.R. 2148) – and passed the House by voice vote in

November of last year. The Senate Banking Committee then took up an identical HVCRE bill

(S. 2405) co-sponsored by Senators Tom Cotton (R-AR) and Doug Jones (D-AL), which passed

in March as part of the Senate’s broader Dodd-Frank reform legislation (S. 2155). The passage

by the House of S. 2155 included the same language and clarifications to the Basel III High

Volatility Commercial Real Estate (HVCRE) Rule.

The new measure addresses key deficiencies in the agencies’ current and proposed regulations

by providing the following modifications and clarifications to either an HVCRE or High

Volatility Acquisition, Development or Construction (HVADC) loan:

Commercial borrowers will be able to satisfy the 15% equity requirement through the

appreciated value of contributed land/property – versus the cost basis under the current rule.

A new exemption would be added to the HVCRE rule covering acquisition/refinancing loans

for performing income producing properties. It clarifies that loans made to acquire existing

property with rental income and/or do cosmetic upgrades and other improvements don't

trigger the capital penalty.

Allows borrowers to use internally generated capital in the project and, once the

development/construction risk period has passed, outside the project, rather than forcing

them to refinance the loan (possibly away from the original lender).

All ADC loans made prior to January 2015 would be grandfathered and do not have to satisfy

current HVCRE exemption criteria.

Banks would able to withdraw HVCRE status prior to the end of an ADC loan’s term.

The Law was effective upon the President signing the legislation which clarifies and changes

the federal Banking Regulators’ HVCRE Rule as well as their proposed HVADC Rule.

The legislative action is a welcome solution to a poorly designed regulatory capital scheme that

was not matched with risk. This caused an unnecessary cost burden to all commercial banks and

their real estate development customers. In addition, it restores to borrowers the ability to offer

appreciated land value as equity to banks, when validated through appraisal practices established

in earlier statutes. In clearly defining HVCRE exposures, this legislative solution halts the

regulatory experimentation in creating pools of commercial real estate development risk,

including last year’s HVADC trial balloon of a use of proceeds test on unsecured transactions,

requiring capital support where it did not exist.

1July 27, 2015

Via E-mail Honorable Janet Yellen Honorable Thomas J. Curry Chair Comptroller of the Currency Board of Governors of the Office of the Comptroller of the Currency Federal Reserve System 250 E Street, SW 20th St. & Constitution Ave., NW Washington, DC 20219 Washington, DC 20551 Honorable Martin J. Gruenberg Chairman Federal Deposit Insurance Corporation 550 17th Streeet, NW Washington, DC 20429 Re: April 6, 2015, Frequently Asked Questions on the Basel III Regulatory Capital Rule, High Volatility Commercial Real Estate

Ladies and Gentlemen:

The Real Estate Roundtable1 (www.rer.org) is pleased to provide the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (collectively, the “Agencies”) with its perspectives on the Agencies’ Frequently Asked Questions on the Regulatory Capital Rule (“FAQs”) issued on April 6, 20152. The comments in this letter are focused on the treatment of exposures to “High Volatility Commercial Real Estate” (“HVCRE”) under the Agencies’ final Basel III risk-based capital rules issued in October 2013 (“the “Basel III Rules”)3.

The Real Estate Roundtable supports the Agencies’ efforts to ensure the safety and soundness of the banking system; promote economically responsible commercial real estate lending that reflects sound underwriting and risk management practices; and to sustain the stability and reliability of commercial real estate capital and credit markets. To that end, the Basel III Rules represent a good foundation for enhanced stability in commercial real estate lending.

1 The Real Estate Roundtable and its members lead an industry that generates more than 20 percent of America’s gross national product, employs more than 9 million people, and produces nearly two-thirds of the taxes raised by local governments for essential public services. Our members are senior real estate industry executives from the U.S.’s leading income-producing real property owners, managers and investors; the elected heads of America’s leading real estate trade organizations; as well as the key executives of the major financial services companies involved in financing, securitizing, or investing in income-producing properties. 2 Frequently Asked Questions on the Regulatory Capital Rule (Mar. 31, 2015), available at http://www.occ.gov/ news-issuances/bulletins/2015/bulletin-2015-23.html. 3 78 Fed. Reg. 62,018 (Oct. 11, 2013).

Board of Directors

Chairman William C. Rudin CEO & Vice Chairman Rudin Management Company, Inc.

President and CEO Jeffrey D. DeBoer

Treasurer Thomas M. Flexner Global Head of Real Estate Citigroup

Secretary Debra A. Cafaro Chairman and CEO Ventas, Inc.

Thomas R. Arnold Head of Americas-Real Estate Abu Dhabi Investment Authority Chairman, Association of Foreign Investors in Real Estate and Chairman, Pension Real Estate Association

Jeff T. Blau CEO Related Companies

Steve Brown 2014 President National Association of Realtors®

Tim Byrne President and CEO Lincoln Property Company Member, National Multifamily Housing Council

Richard B. Clark Chief Executive Officer Brookfield Property Partners

David J. LaRue President and Chief Executive Officer Forest City Enterprises, Inc.

Stephen D. Lebovitz President and Chief Executive Officer CBL & Associates Properties, Inc. Chairman, International Council of Shopping Centers

Anthony E. Malkin Chairman, CEO and President Empire State Realty Trust

Roy Hilton March Chief Executive Officer Eastdil Secured

George M. Marcus Chairman Marcus & Millichap Company

Robert R. Merck Senior Managing Director and Head of Real Estate Investments MetLife

David Neithercut President and Chief Executive Officer Equity Residential Chairman, National Association of Real Estate Investment Trusts

Ross Perot, Jr. Chairman Hillwood

Douglas W. Shorenstein Chairman and CEO Shorenstein Properties LLC

Robert J. Speyer President and Co-CEO Tishman Speyer

Barry Sternlicht Chairman and CEO Starwood Capital Group

Robert S. Taubman Chairman, President and CEO Taubman Centers, Inc. Immediate Past Chairman The Real Estate Roundtable

W. Edward Walter President and CEO Host Hotels & Resorts, Inc.

July 27, 2015 Page 2

Although the Real Estate Roundtable supports the Basel III Rules, we believe the Agencies should take appropriate steps to quickly modify or further clarify certain aspects of the rules related to HVCRE exposures that are addressed by the FAQs. Without modifications, the consequences of the 150% risk weight under the Basel III Rules for HVCRE exposures will have a deleterious economic impact on commercial real estate acquisition, development and construction (“ADC”) lending conducted by U.S. banking organizations.

To account for the increased risk-weight for HVCRE exposures and the resulting incremental capital that must be held, it has been estimated that a banking organization will require a substantial increase in the interest rate charged to the client. The higher rate will increase the cost of development if passed on to the borrower or will reduce bank income if not. A bank’s aggregate commercial real estate (“CRE”) lending limits are supported by an allocation of the bank's regulatory capital (“RC”) for that purpose. Since each bank has a finite amount of RC, RC is the scarce and constraining resource which determines the overall size of its risk-weighted balance sheet. To the extent HVCRE has a higher risk weighting, it consumes a greater amount of RC and therefore reduces both the amount of RC available for other CRE lending and the amount of RC left to support other bank lending businesses. Therefore, even if the interest rate charged to an HVCRE borrower is increased to compensate for the higher RC allocation, it also has the potential to limit the amount of overall CRE credit availability provided by that bank.

We believe the Basel III Rules’ requirements for HVCRE commercial real estate project exemption and the clarifications of those requirements in the FAQs do not reflect the actual periods of development risk, causing banks to carry the HVCRE exposures at the increased 150% risk weight (the same risk weight as a 60-day overdue loan) longer than necessary to protect against losses on development loans. This places an undue burden on commercial real estate developers, increasing costs and altering project economics.

Prohibition of Withdrawal of Internally Generated Capital

Under the Basel III Rules, designation of an exposure as HVCRE could be avoided if the borrower contributes 15% of the “as completed” value in cash or cash equivalents as equity into a project before bank funding and if such equity is retained over the life of the loan. Because of market conditions over the past few years, many of the larger development projects have been funded with equity amounts in excess of 15%.

It has been a long standing industry practice to document the conditional use of internally generated funds for project expenses and, as the project stabilizes, permit distribution of such funds to the owners based on the achievement of contractual performance tests. The FAQs disallow the 15% equity HVCRE exemption if the governing loan documents provide a right to a distribution. While providing the clarity sought by banks regarding the application of the Basel III Rules, prohibiting distributions over the life of the loan to retain the HVCRE exemption is overly harsh. It equates the contractual term of a construction loan to the period of development risk, which is not the case.

Having a minimum 15% equity contribution coupled with the requirement that all contributed and internally generated capital remain in the project throughout the life of the loan could create an unintended incentive to have the borrower limit initial equity to just the initial 15%. They could argue that since internally generated capital cannot be distributed, it will build up over time to the protection of the bank. In this regard, the 15% equity becomes, in the borrowers’ mind, a cap – not a floor. If the initial equity investment is to create “skin in the game”, why have a regulation that works to encourage limiting it to that amount?

July 27, 2015 Page 3

Commercial construction lending processes and bank portfolios are subject to strong regulatory oversight, including regular reviews and targeted examinations. Risk management practices at banks include closely monitoring project performance for internal risk rating purposes and for setting of reserves. It is common for construction loan documents to allow for banks to confirm project performance, determine that development risk has passed and that the project has stabilized, upgrade the risk rating and, following loan terms, allow distributions to be made to investors as a return on their investment.

Bank Confusion on Interpretation of the Rules

An examination of Call Report filings as of March 31, 2015 by banks on their HVCRE exposures from otherwise disclosed construction exposures evidences a wide range of values indicating inconsistent interpretation and determination. While the FAQs provide clarity that allowing any distributions under the terms of applicable agreements negates the equity-based exemption, the bank reporting indicates a level of confusion and/or inconsistency between traditional development loan risk management processes currently followed and overseen by regulators and the contractual term-based approach over the life of the loan expressed in the Basel III Rules and reinforced in the FAQs.

It appears that issuing the FAQs, in lieu of specific written policy, long after the January 1, 2015 implementation date for HVCRE risk-based capital reporting and even after the initial reporting period of March 31, 2015, may have contributed to the confusion. Because of the 150% risk weight and the reporting disparities, it is possible that moving all banks to uniform reporting under a strict interpretation may cause a near term reduction in construction loan availability, an unintended consequence of implementation process. In addition, the FAQs were not responsive to many of the concerns regarding the application of the Basel III Rules raised earlier to the Agencies by commercial real estate lenders and borrowers.

We are highly concerned that the guidance provided by the FAQs in conjunction with the Basel III Rules’ requirements on HVCRE exposures may:

- disrupt availability of development credit from banks to the commercial real estate sector;

- reduce overall credit capacity for commercial real estate development lending in the U.S.;

- increase loan pricing to all borrowers, with a likely greater impact to smaller borrowers with less valuable relationships; and

- add to project development costs even after ADC risk has passed.

This could have the unintended consequence of pushing construction lending into the shadow banking market, thus increasing overall risk to the financial sector and defeating the original purpose of the measure.

We urge the Agencies to quickly modify or further clarify the FAQs so as to require banks to apply the 150% risk weight solely during the development risk period. Further, we urge the Agencies to allow the loan agreements to permit the use of internally generated funds after that period has passed and retain the HVCRE exemption if the other exemption criteria have been satisfied, such as the 15% initial equity test.

July 27, 2015 Page 4

If this is done, we believe potential disruption to the availability of development capital from banks in the implementation of HVCRE reporting will be prevented. The higher 150% risk weight will be applied where the development risk exists rather than the life of the loan. Finally, the pressure to have the 15% equity test viewed by the industry as a ceiling rather than a floor would be mitigated.

Using “as completed” Appraisal Values for Initial Equity Determination Focuses Solely on Completion, not Lease-up Risk of ADC Loans

We also note that higher quality to-be-built net-leased projects are negatively impacted. The 15% cash equity requirement measured against the “as completed” value of the project. When a project is a build-to-suit/pre-leased project, the gap between “as completed” and “as stabilized” values will be small, thus increasing the cash equity requirement on projects the appraisal has established are less risky based on value being created. If you have a higher risk speculative project, the “as completed” value will be less than the “as stabilized” value. From the HVCRE ruling conclusion, a project like this could require less cash equity, which has the opposite effect that one would expect for risk and return.

This anomaly could create an economic incentive for developers to seek financing without securing pre-leasing thereby lowering the “as completed” value, which in turn lowers the required equity contribution to achieve the 15% exemption. This increases the likelihood that banks will be asked to finance “spec” development, even when market conditions call for or support pre-leasing.

Basing a required equity amount on the total project cost as one factor to qualify for HVCRE exemption would eliminate penalizing developers for business practices that reduce development risk.

Recognition of Appreciated Land Value

We believe there should be more industry dialogue around the nature of the 15% equity contribution specifically related to the contributed land value. There are circumstances where the current value of commercial land contributed to a project is significantly higher than the original purchase price of that land. Value is improved with the passage of time or via owner action by securing zoning use changes or increases in density that should be considered. These are market recognized positive changes in value that, with appropriate safeguards such as thorough bank review and compliant appraisal valuation, should be included in the contribution of equity to a financing. Disallowing this for development financing purposes penalizes developers and raises the cost of financing.

Solicit Industry Feedback

It is also important to actively understand the economic impact the Basel III Rules could have on commercial real estate markets and the broader economy. Accordingly, it is vital that the Agencies appropriately monitor the application and administration of the Basel III Rules to ensure that such application and administration is balanced, consistent and otherwise conforms to the Agencies’ intentions. As one element of such monitoring, the Roundtable respectfully suggests that the Agencies sponsor periodic industry forums. These forums would permit institutions, their customers, and other interested parties to provide feedback to the Agencies on the implementation of the capital rules in the field. Such forums, held on a quarterly or semiannual basis, could serve as an early warning system to alert the Agencies regarding potential issues with respect to the administration and implementation of the capital rules.

July 27, 2015 Page 5

This feedback would allow the Agencies to appropriately address any possible unintended economic consequences resulting from the Basel III Rules by supervisory personnel or by the institutions they supervise that might threaten the soundness of the banking system or the stability of the real estate lending market on which such soundness depends in significant part.

Commercial banks constitute our nation’s largest source of commercial real estate financing. A sudden and significant contraction of bank credit available for commercial real estate could lead to a decline in property values and in the economic condition of existing borrowers. Such a decline would, in turn, reduce the quality of outstanding loans and thus threaten the health of banks that are significantly concentrated in commercial real estate, which would likely lead such banks to further curtail credit. Unfortunately, we have experienced such vicious cycles in the past and seen the consequences for our economy as a whole. This experience underscores the importance of ensuring that the capital rule is applied and administered with care; otherwise, the new rule can become a self-fulfilling prophecy, inducing the very same consequences it seeks to prevent.

We trust that the Agencies will find our few comments helpful. Should you have questions or require additional information, please contact Clifton E. Rodgers, Jr., by telephone at (202) 639-8400 or by email at crodgers@rer.org.

Thank you for the opportunity to comment on this important issue.

Sincerely, Jeffrey D. DeBoer President and Chief Executive Officer

Fed cc: Scott G. Alvarez, Michael S. Gibson, Mark E. Van DerWeide, Timothy P. Clark, Anna Lee Hewko, Constance Horsley, Laurie S. Schaffer, Christine E. Graham OCC cc: Amy S. Friend, Martin Pfinsgraff, Charles Taylor, Darrin Benhart, Richard B. Taft, Amrit P. Sekhon, Margot Schwadron, David Elkes, Ron Shimabukuro, Carl Kaminski, Patrick Tierney FDIC cc: Charles Yi, Doreen R. Eberley, Jason Cave, Bobby R. Bean, Ryan Billingsley, Benedetto Bosco, Michael Phillips

VIA ELECTRONIC SUBMISSION December 21, 2017

Office of the Comptroller of the Currency

Legislative and Regulatory Activities Division

400 7th Street SW., Suite 3E-218, Mail Stop 9W-11

Washington, DC 20219 Docket ID OCC–2017–0018; RIN 1557–AE10

Federal Deposit Insurance Corporation

Robert E. Feldman, Executive Secretary

Attention: Comments/Legal ESS

550 17th Street NW

Washington, DC 20429

RIN 3064 AE-59

Board of Governors of the Federal Reserve System

Ann E. Misback, Secretary

20th Street and Constitution Avenue NW

Washington, DC 20551

Docket No. R–1576; RIN 7100 AE-74

Re: October 27, 2017, Notice of Proposed Rulemaking, Basel III High Volatility Acquisition Development or Construction (HVADC), “Simplifications to the Capital Rule Pursuant to the Economic Growth and Regulatory Paperwork Reduction Act of 1996”

Ladies and Gentlemen:

The Real Estate Roundtable1 (www.rer.org) is pleased to provide the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (collectively, the “Agencies”) with its perspectives on the Agencies’ Simplifications to the Capital Rule Pursuant to the Economic Growth and Regulatory Paperwork Reduction Act of 1996 issued on October 27, 2017.2

1 The Real Estate Roundtable and its members lead an industry that generates more than 20

percent of America’s gross national product, employs more than 9 million people, and

produces nearly two-thirds of the taxes raised by local governments for essential public

services. Our members are senior real estate industry executives from the U.S.’s leading

income-producing real property owners, managers and investors; the elected heads of

America’s leading real estate trade organizations; as well as the key executives of the major

financial services companies involved in financing, securitizing, or investing in income-

producing properties.

2 Simplifications to the Capital Rule Pursuant to the Economic Growth and Regulatory

Paperwork Reduction Act of 1996, available at:

https://www.federalregister.gov/documents/2017/10/27/2017-22093/simplifications-to-the-

capital-rule-pursuant-to-the-economic-growth-and-regulatory-paperwork#print

Board of Directors

Chair William C. Rudin CEO and Co-Chairman Rudin Management Company, Inc.

Chair-Elect and Secretary Debra A. Cafaro Chairman and CEO Ventas, Inc.

President and CEO Jeffrey D. DeBoer

Treasurer Thomas M. Flexner Global Head of Real Estate Citigroup

Thomas R. Arnold Deputy Global Head and Head of Americas-Real Estate Abu Dhabi Investment Authority

Kenneth F. Bernstein President and Chief Executive Officer Acadia Realty Trust Chairman, International Council of Shopping Centers

Jeff T. Blau CEO Related Companies

Steve Brown Past President National Association of Realtors®

Tim Byrne President and CEO Lincoln Property Company

Richard B. Clark Senior Managing Partner & Chairman Brookfield Property Group

Kevin Faxon Managing Director – Head of Real Estate Americas J.P. Morgan Asset Management Chairman, Pension Real Estate Association

John F. Fish Chairman and CEO SUFFOLK

Anthony E. Malkin Chairman and CEO Empire State Realty Trust

Roy Hilton March Chief Executive Officer Eastdil Secured

Jodie W. McLean Chief Executive Officer EDENS

Robert R. Merck Senior Managing Director and Head of Real Estate Investments MetLife

Timothy J. Naughton Chairman, CEO and President AvalonBay Communities, Inc. Immediate Past Chair, Nareit

David Neithercut President and Chief Executive Officer Equity Residential

Ross Perot, Jr. Chairman Hillwood

Rob Speyer President and CEO Tishman Speyer

Barry Sternlicht Chairman and CEO Starwood Capital Group

Robert S. Taubman Chairman, President and CEO Taubman Centers, Inc. Immediate Past Chair The Real Estate Roundtable

Owen D. Thomas Chief Executive Officer Boston Properties

December 21, 2017 Page 2

The comments in this letter are focused on the Notice of Proposed Rulemaking (NPR), “Simplifications of and Revisions to the Capital Rule related to High Volatility Acquisition Development or Construction (HVADC) Exposures” as issued on October 27, 2017.3

The Real Estate Roundtable supports the Agencies’ efforts to ensure the safety and soundness of the banking system; promote economically responsible commercial real estate lending that reflects sound underwriting and risk management practices; and to sustain the stability and reliability of commercial real estate capital and credit markets. To that end, the Basel III Rules represent a good overall foundation for enhanced stability in commercial real estate lending.

We also appreciate the stated intentions of the Agencies to simplify aspects of the generally applicable capital rules related to the treatment of acquisition, development or construction (ADC) loans consistent with the Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA).

The NPR would replace the definition of a High Volatility Commercial Real Estate (HVCRE) exposure in the standardized approach with a new High Volatility Acquisition, Development, or Construction (HVADC) exposure category. Some of the proposed simplifications and clarifications may increase the ADC scope, and others may decrease it.

Accordingly, the Agencies are proposing to apply a lower risk weight to the proposed HVADC exposure category, applying a 130 percent risk weight to HVADC exposures – a reduction from the 150 percent risk weight to HVCRE exposures under the current rule. It is unclear if the reduction is based on any new analysis of CRE losses or to make the proposed changes to ADC identification and reporting more palliative to standard approach banks.

The NPR would not revise the treatment of HVCRE exposures for purposes of calculating the amount of capital required under the advanced approaches. Instead, the proposal would grandfather existing ADC exposures, and advanced approach banking organizations would use the proposed HVADC exposure category for the purposes of calculating their capital requirements under the standardized approach in addition to continuing reporting under the HVCRE definition for their advanced approach capital determination.

In the NPR, the Agencies make note of observing an apparent gap in HVCRE determination and reporting by banks in the required filings of the FR Y-14 and Call Reports. Despite wide-ranging concerns raised in a multiplicity of comment letters submitted to the Agencies regarding the current HVCRE rule, the NPR does not clarify the existing HVCRE definition which continues to be required from advanced standards banks – instead it creates a new exposure category – HVADC. We raise the following concerns about the NPR:

The bifurcation of HVCRE and HVADC exposures only complicates large bank reporting of essentially the same risk. Without one framework that would apply to both HVCRE and HVADC exposures, banks face the challenge of coordinating the respective risks of HVCRE and HVADC exposures, continuing the disruption between banks and developers over development and/or construction financing and hampering multibank syndication of larger deals. We recommend establishing a single, coordinated framework that applies to the risk targeted by HVCRE and HVADC so that one framework applies to both advanced approach and standardized approach banks.

3 12 CFR 217.21(Board); 12 CFR 3.21 (OCC); 12 CFR 324.21 (FDIC)

December 21, 2017 Page 3

Under the HVCRE rules, the 15 percent equity requirement for HVCRE exclusion was presented as a “skin in the game” inducement to borrowers to lower the risk weight of ADC loans. It makes no sense to eliminate this equity exemption and possibly increase the exposure risk of having less equity in the transaction, while lowering the loan’s capital surcharge rate to 130 percent.

In addition, the NPR fails to provide clarity on the issue of what constitutes an "equity" contribution to a loan structure. For greater clarity, we direct you to the language in the House-passed HVCRE legislation4 which allows banks to establish borrower contributed land value as equity into projects as established by certain safeguards, such as a fully-compliant appraisal and thorough bank review.

The current and proposed rules pull many stabilized loans without construction risk into this HVCRE category, including properties acquired and being upgraded while rental income continues, unduly burdening cash flow supported loans with capital charges intended to protect banks from heightened construction risks. Many banks, including small community financial institutions, have been deterred from making this type of loan – driving the business to unregulated, higher cost debt funds.

The NPR also fails to address the need to amend the HVCRE equity requirement for advanced standards banks that all contributed and internally generated capital remain in the project throughout the life of the loan. This requirement creates an unintended incentive to have the borrower limit their total equity contribution to just the exemption-driven 15 percent. In cases when equity greater than 15 percent is contributed, they would endeavor to repay the bank in full as soon as possible when development risk has passed in order to repatriate their equity, depriving banks of the income associated with a stabilized loan that would bolster capital.

The NPR also ignores the fact that current exam structures within the regulators on commercial banks monitor the CRE risk on the books and verify risk processes. Plus, Comprehensive Capital Analysis and Review (CCAR) establishes its own CRE schedule and is the binding control for banks over $250 billion.

Capturing Unsecured Cash Flow Underwritten Exposures as CRE Risk

Expanding the ADC reporting pool by creating a purpose test will capture exposures for ADC purposes that are fully supported by other acceptable repayment sources and non-CRE secured loan structures. For example, similar to other corporate borrowers, real estate investment trusts (REITs) use a mix of revolving bank debt, term loans and privately placed and publicly issued debt securities as part of their capital structure. Investment grade rated REITs generally benefit from credit facilities that are both unsecured and on terms more favorable to the borrower than can be obtained by non-investment grade rated companies. The loans associated with these credit facilities while used for ADC purposes are corporate loans – not CRE loans – and are underwritten based on the financial strength of the overall company, its underlying assets and cash flow. A large percentage of the U.S. equity REIT market has investment grade ratings.

Equity REITs have low leverage ratios. As of January 2017, the debt-to-total market capitalization of the equity real estate investment trust (REIT) market (debt divided by the sum of debt and equity) was 31.9 percent – the lowest since the end of 1997. The debt-to-total book-assets ratio of the market was 49.0 percent, down from a post-crisis peak of 57.5 percent in the first quarter of 2009, and the lowest level on record since 2000.5

4 Clarifying High Volatility Commercial Real Estate Loans (H.R. 2148) 5 Equity REITs Have Lowest Debt Ratio In 20 Years, NAREIT, January 9, 2017.

December 21, 2017 Page 4

For these reasons, investment-grade REIT revolving bank debt has proven to be one of the safest debt exposures for banks. Should the proceeds of such a facility be used for an ADC loan, the NPR would pull that portion of the facility under the ADC capital surcharge – requiring a substantial increase in the risk weight and a dramatic increase the cost of borrowing for REITs, while also impacting many bank loan syndications. We encourage the Agencies not to undermine the structure of investment grade credit facilities and bank loan syndications by imposing a collateralized HVADC requirement on these unsecured lines.

One key underwriting factor involved in ADC lending is establishing borrower intent with regard to the purpose of the loan. In certain cases, bank documents prohibit borrowers from using credit facilities in certain ways. In order to ensure that borrowers do not use unsecured cash flow underwritten facilities for ADC purposes, banks would have to add language to their agreements which is commercially unfeasible, which could drive financing to unregulated sources.

Current HVCRE Rules: Agencies Fail to Respond to Industry Concerns

The Agencies have failed to respond to stakeholder questions and provide clarification of the HVCRE Rule. The lack of clarity in the Rule and subsequent HVCRE Frequently Asked Questions (FAQs) published by the Agencies on March 31, 2015 has resulted in a wide disparity in how banks classify their ADC portfolios as HVCRE or non-HVCRE. This result has negatively impacted ADC loan decisions for some banks, leaving some borrowers with fewer and potentially more costly sources of ADC loan capital. A slowdown in ADC lending has the potential for broader economic impact.

The Agencies’ continual failure to respond to legitimate industry concerns about the need for standardization and clarity in HVCRE rules reflects an apparent lack of familiarity by their regulatory capital planning arms with the practice and dynamics of commercial real estate (CRE) lending which are well known to their own risk examination arms.

It is not clear that there is any bank safety rationale for separately requiring unclarified HVCRE reporting by advanced standards banks – instead it appears intended as a penalty on banks for offering a debt capital product for real estate development.

In addition, it is not clear that the Agencies have any empirical data or research that supports the premise of capital calculated from any such risk weight be it 130% or 150% as protecting a bank from ADC risk exposures – raising the question of whether there should be any capital surcharge at all.

As a result of the negative impact that the current HVCRE rules are having on ADC lending, a number of unregulated, shadow-market funds are filling the void. Banks risk losing their long-established, valuable CRE development customers to this growing non-banking shadow-market. Ironically, these funds utilize bank loans for leverage to meet their yield targets. While the leverage is coming from banks, the facilities are outside the scope of existing regulatory CRE reporting schemes.

Legislative Action

Meanwhile, the U.S. House of Representatives recently passed a bipartisan measure – Clarifying High Volatility Commercial Real Estate Loans (H.R. 2148) – that would help address concerns regarding the HVCRE rules by amending the Federal Deposit Insurance Act to clarify the certain requirements for certain acquisition, development, or construction loans (ADC).

December 21, 2017 Page 5

The House-passed legislation addresses several specific deficiencies in the Agencies’ regulations governing what is an HVCRE loan to ensure that they do not impede credit capacity or economic activity, while still promoting economically responsible commercial real estate lending. As such, the legislation does not eliminate the Agencies’ ability to require banks to hold higher capital for HVCRE loans (150 percent). Rather, the bill provides the clarity which the Agencies have yet to provide, including which types of loans should and should not be classified as HVCRE loans.

Among the clarifications in the legislation are the following:

Once the development/construction risk period has passed, and the project is cash flowing, it would allow borrowers to use internally generated cash outside the project, rather than forcing them to refinance the loan (possibly away from the original lender).

Clarify that loans made to do general upgrades and other improvements on existing properties with existing or continuing rental income, even after acquisition, do not trigger the capital penalty.

Allows banks to establish borrower land value as equity into projects as established by certain safeguards, such as a fully-compliant appraisal and thorough bank review.

Excludes from application and compliance any loans made before January 1, 2015.

The legislation would clarify and modify the HVCRE rules to ensure that they are appropriately calibrated and do not impede credit capacity or economic activity, while still promoting economically responsible commercial real estate lending.

Of the $3.9 trillion in commercial real estate debt outstanding, commercial banks constitute our nation’s largest source of commercial real estate financing. Yet, over $1 trillion is maturing though 2019 – including $469 billion in bank debt. Without adequate credit capacity, this wall of maturities could create problems in the banking system and the broader economy.

Since the Rule’s effective date of January 1, 2015, necessary clarification for key elements of the Rule have not been provided by the Agencies despite ongoing requests. Instead, the Agencies issued a Notice of Proposed Rulemaking on Oct. 27, 20176 that fails to clarify the existing HVCRE definition which continues to be required from advanced standards banks – instead it creates a new exposure category.

The Agencies were aware that H.R. 2148 had nearly unanimous support in the House Financial Services Committee, yet they released the HVADC NPR under the guise of paperwork reduction act instead of responding to repeated requests for clarity. With the House passage of H.R. 2148, it is clear that the House of Representatives and its Financial Services Committee are telegraphing a very strong message to the regulators regarding the need to address and clarify industry concerns about the Basel III HVCRE rules.

6 October 27, 2017, Notice of Proposed Rulemaking, Basel III High Volatility Acquisition Development or Construction

(HVADC), “Simplifications to the Capital Rule Pursuant to the Economic Growth and Regulatory Paperwork Reduction

Act of 1996”

December 21, 2017 Page 6

We encourage the Agencies to review the language in Clarifying High Volatility Commercial Real Estate Loans (H.R. 2148)7 and utilize such an approach to clarify the current HVCRE rules and build on this construct in a new consolidated HVCRE/HVADC rule.

We appreciate the opportunity to comment on this important proposed rule and welcome the opportunity to meet with the Agencies to expand on the views expressed in this letter. Should you have questions or require additional information, please contact Clifton E. Rodgers, Jr., by telephone at (202) 639-8400 or by email at crodgers@rer.org.

Sincerely, Jeffrey D. DeBoer President and Chief Executive Officer

Attachment

7 A copy of H.R.2148 is attached to this comment letter.

Comparison of High Volatility Commercial Real Estate (HVCRE) with H.R. 2148/S. 2155

Proposed High Volatility Acquisition, Development, and Construction Loans, and

Basel III Revisions

Last updated on May 24, 2018

Reprinted with permission of CRE Finance Council

Disclaimer: The information provided herein is general in nature and for educational purposes only. CRE Finance Council makes no representations as to the accuracy, completeness, timeliness, validity, usefulness, or suitability of the information provided. The information should not be relied upon or interpreted as financial, tax, accounting,

investment, commercial or other advice, and CRE Finance Council disclaims all liability for any such reliance. © 2018 CRE Finance Council. All rights reserved.

© 2018 CRE Finance Council. All rights reserved.

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Compared Documents• HVCRE Final Rule & FAQS

• Rule Effective January 1, 2015• FAQs Released March 2015

• H.R. 2148/S. 2405• H.R. 2148 introduced April 2017; Passed House November 2017• S. 2405 introduced February 2018• H.R. 2148/S.2405 incorporated into S.2155, which passed Senate in March 2018.• S. 2155 Passed House May 2018• Signed into Law by the President on May 24, 2018 and effective immediately

• Notice of Proposed Rulemaking on HVADC• Proposed September 2017• Comment Period Closed December 2017

• Basel Committee Standard (Dec. 2017)

© 2018 CRE Finance Council. All rights reserved.

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List of Compared Topics• Applicability—Banks • Scope—Loans • Exemptions• Definition of Permanent Loan• Conversion to Non-HVCRE• Contributed Capital• Grandfathering• Risk Weight

Topic Current HVCRE H.R. 2148/S. 2155 HVADC Basel III (Dec 2017)

References C.F.R. 12 § 324.2H.R. 2148 Bill Text

S. 2155 Bill TextNPR Text Basel III: Finalizing post-crisis reforms

Ap

plic

abili

ty -

Ban

ks

Same definition for both Advanced Approaches (AA) and Standard Approach (SA). SA risk weight is 150%; AA risk weight is variable.

Same definition and risk weight for both AA and SA.

HVADC definition and risk weight apply only to SA.

AA maintain current HVCRE weights and definition.

Sco

pe

-Lo

ans

“a credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property,”

“(1) a credit facility secured by land or improved real property that , prior to being reclassified by the depository institution as a Non-HVCRE ADC Loan …”:

(A) Primarily finances, refinances or has financed 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;

“a credit facility that is originated on or after [effective date] and that: (1) Primarily finances or refinances the: (i) Acquisition of vacant or developed land; (ii) Development of land to prepare to erect new structures including, but not limited to, the laying of sewers or water pipes and demolishing existing structures; or (iii) Construction of buildings, dwellings, or other improvements including additions or alterations to existing structures

Note: Commentary defines "primarily finances" as more than 50% of the loan proceeds will be used for ADC activities.

The primary source of repayment of the obligation is the income generated by the asset(s), rather than the independent capacity of a broader commercial enterprise• CRE exposures secured by properties of types that are categorized by the national supervisor as sharing higher volatilities in portfolio default rates; • Loans financing any of the land acquisition, development and construction (ADC) phases for properties of those types in such jurisdictions; and • Loans financing ADC of any other properties where the source of repayment at origination of the exposure is either the future uncertain sale of the property or cash flows whose source of repayment is substantially uncertain (eg the property has not yet been leased to the occupancy rate prevailing in that geographic market for that type of commercial real estate).

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Topic Current HVCRE H.R. 2148/S. 2155 HVADC Basel III (Dec 2017)

Exe

mp

tio

ns

1. 1-4 family residential

2. Community Development Investment

3. Agriculture land

4. CRE Projects with:

A. LTV ratio within applicable standards;

B. 15% borrower contributed capital

C. Capital contribution and internally generated funds required to remain in project until permanent conversion, sale, or paid in full.

1. 1-4 family residential; Community Development Investment; Agriculture land;

2. Acquisition or refinancing of income-producing real property if cash flow is sufficient;

3. Improvements to existing income-producing real property if cash flow is sufficient;

4. CRE Projects with: A. LTV ratio within applicable

standards; B. 15% borrow contributed capital

(clarifications)C. 15% capital contribution required

to remain in project until reclassification. Excess contribution can be withdrawn

1. 1-4 family residential2. Community Development Investment3. Agriculture land4. Permanent loan

1. Commercial ADC loans exempted from treatment as HVCRE loans on the basis of certainty of repayment of borrower equity are, however, ineligible for the additional reductions for SL exposures described in paragraph 58.

De

fin

itio

n o

f P

erm

ane

nt

Loan

Not Defined“institution’s applicable loans underwriting criteria for permanent financings”

“A permanent loan for purposes of this definition means 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. For purposes of this section, a permanent loan does not include a loan that finances or refinances a stabilization period or unsold lots or units of for-sale projects.“

Not Defined

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Topic Current HVCRE H.R. 2148/S. 2155 HVADC Basel III (Dec 2017)

Co

nve

rsio

n t

o N

on

-H

VC

RE/

HV

AD

C

Not Defined

Upon (1) completion of development or construction of real property; and (2) cash flow is sufficient to support the debt service and expense of real property, to satisfaction of lender in accordance with permanent financing.

Commentary suggests that “even if a credit facility does not meet the definition of a permanent loan at origination, it could subsequently meet the definition as the property generates additional revenue sufficient to service amortizing principal and interest payments. In such a case, the facility may become exempt from the HVADC exposure category, provided the loan was prudently underwritten at origination. “

Not Defined

Co

ntr

ibu

ted

C

apit

al

15% borrower contributed capital of “as completed”. Contributed land value can be only purchase price, not current appraised value.

15% borrower contributed capital of “appraised as completed value”. Contributed land value shall be appraised value in accordance with FIRREA.

Exemption eliminated.

For ADC exposures to residential real estate, borrower contributed capital to the real estate’s appraised as-complete value. National supervisors to provide further guidance on equity at risk.

Gra

nd

fath

eri

ng

Existing loans not grandfathered. Applied to all past and future loans.

Grandfathers loans originated prior to January 1, 2015.

Only applies to exposures originated on or after the final HVADC rule’s effective date for SA banks.Current outstanding HVCRE loans still retain original HVCRE treatment for all banks. AA banks maintain existing treatment (though they also have to run SA calculations for the purposes of conforming to the Collins Amendment and also in the context f the stress tests).

Not discussed. Implementation target date of January 2022.

Ris

k W

eig

ht

150% (SA)AA current model

150%130% (SA)

AA150% (SA)

95% to 250% Scale (AA)

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