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Community banks, by and large, appear well-prepared for capital standards that Basel II will phase in beginning in January. Still, concerns remain on how the requirements will shape cost structures and consolidation at smaller institutions.
October 1 -
Trade groups press federal banking regulators to make the Basel III capital rule less onerous.
November 13
WASHINGTON Bankers and commercial real estate developers are protesting new restrictions on construction lending, arguing they are poised to hurt credit availability and drive loans into risky, unregulated sectors.
Under Basel III requirements that went into effect this year, regulators created a new category of acquisition, development and construction loans called High Volatility Commercial Real Estate. Such loans face a 150% capital requirement that is making construction loans more expensive and forcing developers to go to nonbank lenders, industry representatives said.
"It doesn't make sense," said Thomas Bisacquino, the president and chief executive officer of NAIOP, which lobbies on behalf of the commercial real estate development industry. "You are moving the better loans out of the banking system."
Regulators added the higher capital charge because of their experiences during the financial crisis. A Federal Deposit Insurance Corp. study found that many banks that failed during that period held large concentrations of acquisition, development and construction loans. A common problem was that by the time construction of new properties was completed, there was low demand for them.
The new capital rules are designed to force borrowers to have more skin in the game. They must meet a 15% equity requirement to avoid the High Volatility CRE designation. The leverage on the loan also cannot exceed 80% of the estimated completed value of the project.
But lenders said these rules don't recognize certain realities in the real estate market. For example, the requirements do not recognize the appreciated value of the land in determining how much equity the developer has to bring to the table.
"The only thing that counts toward the 15% equity is the cash paid for the land," according to George Green, an associate vice president at the Mortgage Bankers Association.
Many developers buy and hold raw land for future projects. "They hold a piece of dirt for 3, 5 or 20 years," Bisacquino said. "This new reg says they have to use the original basis of the land. It is insane."
The Basel III requirements also restrict reclassifying a high volatility construction loan to a permanent CRE credit. Loans considered as high volatility must be held for the full term, according to guidance released by regulators on March 31.
For instance, in the case of a four-year loan where construction is completed in two years and the project is considered "cash flowing," regulatory guidelines dictate that the loan must still be held for the full four-year period, something lenders say is unnecessary.
"MBA has been urging the regulators to allow reclassification earlier once the loan meets the bank's internal underwriting standards," Green said.
The group is also urging regulators to permit an allowance for the appreciated land value to count toward the borrower's 15% equity requirement.
The regulators used to put all construction loans in the 100% risk based capital bucket. The higher 150% risk weighting "will put a damper on [high volatility] CRE lending," said Hugh Carney, vice president for capital policy at the American Bankers Association.
The higher capital requirement will be reflected in the price of loans, and put banks at a competitive disadvantage to nonbank lenders, Carney said.
"If borrowers are able to get better pricing elsewhere, these loans may not be done by the banking system," he said.
In their effort to take the risk out of construction lending, regulators have done the opposite, some industry representatives warn. The rules effectively encourage banks to focus on B-grade projects so they can charge a higher interest rate and cover their cost of capital.
"We are finding the HVCRE rule is embedding perverse incentives into the underwriting process," said Christina Zausner, vice president for policy and industry analysis at the CRE Finance Council, which includes lenders, investors, asset managers and commercial mortgage-backed securities issuers.
To avoid high volatility CRE status, the developer can't take out any equity or any funds internally generated by the project until construction is completed and the acquisition, development and construction loan is converted to a permanent credit. This restricts the borrower from using any cash flow to pay taxes on the project or other expenses.
As a result, the borrower has no incentive go above the 15% equity minimum and tie up more capital in the project. "This rule is telegraphing to borrowers that they shouldn't put anything in except for the minimum," Zausner said. "The regulators got the exact wrong outcome. The banks don't like it either. They are used to getting more equity that that."
MBA is urging the regulators to allow a reasonable use of internally generated capital.
"MBA is working with the agencies to create consistency and fairness with this new regime that reflects tried and true practices that have been part of the construction and lending industry for decades," Green said.
