Two bank trade organizations are urging the Federal Deposit Insurance Corporation to revise its proposed rules for determining whether a bank participation in a real estate project should be considered an investment or a loan.

The American Bankers Association and the Independent Bankers Association of America are concerned that an incorrect classification of a loan as a direct investment would unduly hamper credit in a faltering economy.

Current accounting rules allow lenders to enter into so-called real estate acquisition, development or construction arrangements in which the lender participates in 'expected residual profits." Such profits--from equity kickers, for example--are amounts above what the lender would expect to cam reasonably in fees and interest.

The IBAA said the FDIC proposal could spell trouble for state-chartered banks because it puts too much subjectivity into the examination process, and it could stifle the lending activities of those banks.

In some states, regulators have wrongly treated normal lending practices as equity investments, said Robert Hawkins, IBAA president.

California bankers have reported that regulators are classifying loans where a "lot release fee" is assessed as equity investment, he said. A lot release fee is a common service charge in California that is "backloaded," rather than frontloaded, like points.

"On its face, this transaction may appear to regulators--many of (whom) are not from the state--as an investment." Hawkins noted. "However, this is standard lending practice in California."

Hawkins said not every lending transaction can nor should be the same. He said regulations should be flexible enough to allow banks to take calculated risks and lend to worthy borrowers.

In proposing new rules regulating the activities and investments of state banks, the FDIC intends to treat loans as real estate investments if a) the bank participates in the residual profits of the project and b) the participation has one or more of the other characteristics of a direct investment in real estate or a real estate joint venture.

"The FDIC justifies this treatment on the basis of accounting rules," says Hawkins. Accounting convention recognizes that, depending upon the circumstances, there is little substantive difference between certain loans and direct investments in real estate, and that in those instances, the loans should be accounted for as direct real estate investments."

FDIC's proposal replicates the requirements found in Practice Bulletin 1, which is being revised by the American Institute of Certified Public Accountants. As in PB 1, FDIC would deem a lender participation in a real estate project an investment if the lender:

* Funds the commitment or origination fees, or both;

* Funds all or substantially all the interest fees during the term of the loan;

* Has no security interest other than the project; or

* Structures the arrangement so that foreclosure during development is unlikely (because the borrower is not required to make any payment until the project is completed), or finds that, in order to recoup the investment, the property must be sold.

On the other hand, an ADC arrangement is considered to be a loan if the lender receives less than half the expected residual profit, or if it meets other criteria for loan accounting in PB 1. Also, a lender's participation may be deemed a loan if the lender's money is secured by the borrower's unencumbered assets or guaranteed by a financially sound third party. Cash flows from noncancellable sales contracts or lease commitments from creditworthy third parties also qualify a participation for loan treatment.

IBAA agrees with the FDIC'S proposed approach, but believes the agency should be more flexible in classifying participations as investments and make allowances for different practices in different states.

The group prefers to have two or more of the characteristics present before a participation is considered an investment.

"If a bank has the opportunity to participate in the profits of the project, but chooses not to, the loan should not not be considered an investment," according to Hawkins. "We further recommend that those loans that exhibit one characteristic of a real estate investment be closely monitored during the examination process."

Hawkins said if a bank provides total or substantial funding to an ADC borrower who has little or no equity in the project, all information about the borrower and his or her relationship with the bank will show that it is, in fact, a prudent loan.

Also, it is not unusual for a bank to fund commitments or origination fees. "Without all the facts, it does not appear to be a desirable practice, but that fact alone does not make a loan an investment." Hawkins noted. The ABA noted that the provision exempts ADC property provided the real estate is not held any longer than the shorter of the period set either by state or federal regulators. "We believe that this creates an unfair burden for those state banks that acquired in interest in ADC property prior to Dec. 19, 1991,where those banks relied upon the time period established by the applicable state law retention period," the ABA said.

Dec. 19 was the effective date of the Federal Deposit Insurance Corporation Improvement Act.

The ABA said state law should control for property acquired prior to Dec. 19.

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