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On July 12, 2019, the federal banking agencies[1] released a notice of proposed rulemaking (July NPR) regarding the capital treatment of certain loans that finance land improvements but do not finance the construction of residential homes on the land.

Federal Banking Agencies Release New NPR Expanding HVCRE Proposed Rule

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On July 12, 2019, the federal banking agencies<a class="anchor" id="_ftnref1" href="#_ftn1" name="_ftnref1">[1]</a> released a notice of proposed rulemaking (July NPR) regarding the capital treatment of certain loans that finance land improvements but do not finance the construction of residential homes on the land.<a class="anchor" id="_ftnref2" href="#_ftn2" name="_ftnref2">[2]</a> Such land development loans would be required to be risk-weighted at 150%, rather than the 100% risk-weighting generally accorded to other commercial loans.<a class="anchor" id="_ftnref3" href="#_ftn3" name="_ftnref3">[3]</a> This is to distinguish such loans from loans that finance the construction of one- to four-family residential structures. The latter would continue to be risk-weighted at 100%. Comments on the July NPR are due 30 days after publication in the Federal Register.BackgroundUnder the U.S. capital rules, acquisition, development and construction (ADC) loans characterized as high volatility commercial real estate (HVCRE) exposures are required to be risk-weighted at 150%, rather than the 100% risk-weighting generally accorded to other commercial loans.<a class="anchor" id="_ftnref4" href="#_ftn4" name="_ftnref4">[4]</a> Section 214 of the Economic Growth, Regulatory Relief, and Consumer Protection Act,<a class="anchor" id="_ftnref5" href="#_ftn5" name="_ftnref5">[5]</a> effective May 24, 2018, narrowed the types of ADC loans that may be subject to a heightened risk weight.<a class="anchor" id="_ftnref6" href="#_ftn6" name="_ftnref6">[6]</a> In a notice of proposed rulemaking issued on September 28, 2018 (September NPR), the federal banking agencies proposed to revise their capital regulations to conform to the new law.<a class="anchor" id="_ftnref7" href="#_ftn7" name="_ftnref7">[7]</a>The July NPR supplements the September NPR. The comment period for the September NPR closed on November 27, 2018. A final rule amending the HVCRE exposure definition is not expected until after the July NPR comment period closes.The July NPRBoth the new law and existing regulations provide an exclusion from the heightened capital treatment for credit facilities that finance the ADC of one- to four-family residential structures. After reviewing comments to the September NPR, the federal banking agencies determined that the regulatory capital treatment for lot development loans required further consideration and clarification. In this connection, the federal banking agencies proposed to prevent application of the one- to four-family exclusion to credit facilities for the financing solely of the development of land in preparation for construction of new residential structures. The proposal is based on a determination by the federal banking agencies that such loans carry greater risk.To address this concern, the July NPR would revise the definition of an HVCRE exposure by adding the following clarification:<ul>“For purposes of this definition, credit facilities that do not finance the construction of one- to four-family residential structures, but instead solely finance improvements such as the laying of sewers, water pipes, and similar improvements to land, do not qualify for the one- to four-family residential properties exclusion . . .”</ul>The proposal aligns the one- to four-family exclusion with the instructions to the Call Report and FR Y-9C on line 1.a.(1) of Schedules RC-C and HC-C. Loans that finance both the development of land and the construction of one- to four-family residential structures would generally qualify for 100% risk-weighting. Similarly, loans that finance both the land acquisition and the construction of one- to four-family residential properties, regardless of the stage of construction on the property, also would generally qualify for 100% risk-weighting.  <a class="offset" id="_ftn1" href="#_ftnref1" name="_ftn1">[1]</a> The term “federal banking agencies” refers to, collectively, the Board of Governors of the Federal Reserve System (Federal Reserve); the Office of the Comptroller of the Currency (OCC); and the Federal Deposit Insurance Corporation (FDIC).<a class="offset" id="_ftn2" href="#_ftnref2" name="_ftn2">[2]</a> For a copy of the July NPR, please see:<a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20190712a.htm" target="_blank">https://www.federalreserve.gov/newsevents/pressreleases/bcreg20190712a.htm</a>.<a class="offset" id="_ftn3" href="#_ftnref3" name="_ftn3">[3]</a> Land development loans could still qualify for 100% risk-weighting if they met certain stringent prudential standards set forth in the capital rules.<a class="offset" id="_ftn4" href="#_ftnref4" name="_ftn4">[4]</a> See 12 C.F.R. §324.2 (FDIC); 12 C.F.R. § 217.2 (Federal Reserve); 12 C.F.R. § 3.2 (OCC)(defining “HVCRE exposure”). The 150% risk weight for HVCRE exposures is designated at 12 C.F.R. § 324.32(j) (FDIC); 12 C.F.R. §217.32(j) (FederalReserve); and 12 C.F.R. § 3.32(j) (OCC).<a class="offset" id="_ftn5" href="#_ftnref5" name="_ftn5">[5]</a> The text of the new law is available here: <a href="https://www.congress.gov/115/bills/s2155/BILLS-115s2155enr.pdf" target="_blank">https://www.congress.gov/115/bills/s2155/BILLS-115s2155enr.pdf</a>. For a summary of the provisions included within the new law, please see our Client Alert, available at: <a href="https://media2.mofo.com/v3/assets/blt5775cc69c999c255/blt14c6a563dc09041b/6273ec78b5ad5f2863c5ac3d/180522-financial-regulatory-reform.pdf" target="_blank">https://media2.mofo.com/v3/assets/blt5775cc69c999c255/blt14c6a563dc09041b/6273ec78b5ad5f2863c5ac3d/180522-financial-regulatory-reform.pdf</a>.<a class="offset" id="_ftn6" href="#_ftnref6" name="_ftn6">[6]</a> On July 6, 2018, the federal banking agencies issued guidance to the effect that, prior to any further action from the federal banking agencies, financial institutions may rely on the definition of an HVCRE ADC loan in the new law or, alternatively, on the definition of an HVCRE exposure under current regulations. For our Client Alert discussing the guidance, please see: <a href="https://www.mofo.com/resources/publications/180712-hvcre-exposures.html">https://www.mofo.com/resources/publications/180712-hvcre-exposures.html</a>.<a class="offset" id="_ftn7" href="#_ftnref7" name="_ftn7">[7]</a> For a copy of the September NPR, please see: <a href="https://www.federalreserve.gov/newsevents/pressreleases/bcreg20180918a.htm" target="_blank">https://www.federalreserve.gov/newsevents/pressreleases/bcreg20180918a.htm</a>. For a summary of the September NPR, please see our Client Alert, available at: <a href="https://www.mofo.com/resources/publications/180924-agencies-conform-hvcre-exposure.html">https://www.mofo.com/resources/publications/180924-agencies-conform-hvcre-exposure.html</a>.