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Get your ducks in a row: HVCRE risk management

July 25, 2017
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In a recent Sageworks webinar Robert Ashbaugh, Executive  Risk Management Consultant at Abrigo, discusses High Volatility Commercial Real Estate (HVCRE) lending best practices.

How did we get here?

Ashbaugh’s presentation begins with a quick summary of why regulators care about HVCRE. He starts by reviewing some of the data over the last decade, specifically the role that Acquisition, Development and Construction (ADC) loans played leading up to the 2007 recession. Ashbaugh shows that the peak of construction lending occurred in 2007, when 10% of the loan portfolio for banks under $2 billion in assets was in ADC loans, and about 6% of the loan portfolio for banks greater than $50 billion in assets was in ADC loans. Ashbaugh goes on to demonstrate that the default rates for these loans did not peak until about 2009, and the ALLL did not increase until 2010. Ashbaugh summarizes “HVCRE is really the result of Basel III, which was a direct response to the losses banks took on these loans”.

Leading up the recession and these significant losses, CRE grew in a regulatory environment that “permitted lower capital requirements and did not impose lending caps, merely supervisory limits”. These caps were 100% of capital for construction loans, and 300% for all investor CRE. Ashbaugh highlights that as of 2006, 31% of US banks exceeded at least one of the limits, and that 23% of banks that exceeded both limits failed, while 13% of banks that exceeded the construction limit failed. That 13% represented 80% of the losses to the FDIC insurance fund. “That’s why we’re starting to see all this focus around your ADC, now known as HVCRE portfolio. The regulators want to make sure you have all your ducks in a row, that you have more capital applied to those loans, and you have processes to identify those loans”.

What are HVCRE loans?

Ashbaugh clarifies that HVCRE loans are primarily defined by what they are not. In other words, HVCRE is all ADC loans except for loans that meet certain criteria. The first criteria is loans with an LTV less than or equal to the maximum LTV ratio for their loan type:

  1. 1. Raw land - 65%
  2. 2. Land development - 75%
  3. 3. Non residential construction - 80%
  4. 4. Residential construction - 85%
  5. 5. Construction for improved properties - 85%

A second criteria is that the borrower must make a capital contribution of at least 15% of the “as completed” value for the life of the project, meaning that the capital contribution must be in place before bank funds are advanced, and must remain in place until the loan is converted to permanent financing.

The guidance also outlines some additional exceptions, such as 1-4 Family Residential properties, agricultural land loans, and loans for community and economic development.


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HVCRE risk management

Ashbaugh stresses that the best way to mitigate risk in the HVCRE portfolio is to avoid making loans that qualify as HVCRE by structuring loans to fall within the exemptions in the regulation. Ashbaugh emphasizes that the best way to do that is to know the definitions set forth by examiners, “make sure you and your bankers, and your customers, know what is and what isn’t HVCRE”, and to define your own terms thoroughly. For example, define:

  • - the conversion process to permanent
  • - the equity contribution as a condition precedent
  • - minimum DSCR
  • - as-is LTV

and generally be detailed and specific in the commitment letter and loan documents. By focusing on thorough documentation, banks can better defend their loan classifications to examiners. 

Revisit CRE lending best practices in Rob Ashbaugh's webinar, CRE Lending Market Simplified: Key Insights for 2019.


About the Author


Raleigh, N.C.-based Sageworks, a leading provider of lending, credit risk, and portfolio risk software that enables banks and credit unions to efficiently grow and improve the borrower experience, was founded in 1998. Using its platform, Sageworks analyzed over 11.5 million loans, aggregated the corresponding loan data, and created the largest

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Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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