Construction lending was the root cause of scores of bank failures during the financial crisis and has slowed considerably since then, but that cautionary tale has not deterred banks from advocating for new rules that could revive the business.
A House bill introduced April 26 would ease some of the regulations governing so-called high volatility commercial real estate loans, which are labeled high risk because of potentially inflated values on underlying property, loose underwriting terms or other factors. As a result more of these loans, but not all, would be exempted from costly capital rules.
The bill could help a wide range of banks — from regionals such as PNC Financial Services Group to community banks such as the $153 million-asset Global Bank, a Chinese-American lender in New York — to expand lending for the acquisition, development and construction of real estate. Construction lending has fallen off dramatically since the financial crisis, from 7.3% of total industry lending in March 2009 to 2.7% at March 31 this year, according to BankRegData.com.
Construction lending has picked up recently but is still well off its high, said Christina Zausner, the head of industry and policy analysis at the CRE Finance Council, which represents lenders, investors and developers involved in commercial real estate.
“Construction has been growing a lot slower” than in previous real estate cycles, Zausner said. “HVCRE has been a major headwind.”
The CRE Finance Council and the Mortgage Bankers Association are among the trade groups that have backed the legislation.
Regulators are expected to raise caution flags about weakening oversight of a loan category that contributed so heavily to the financial crisis. Hundreds of banks failed in that period, especially in states such as Florida, Georgia and Illinois; excessive concentrations in construction and development loans were often to blame.
But even regulators have said some changes might be in order. HVCRE loans were flagged as an important issue in a March report to Congress issued by the FDIC, Office of the Comptroller of the Currency, Federal Reserve Board and National Credit Union Administration.
“Replacing the framework’s complex treatment of high volatility commercial real estate (HVCRE) exposures with a more straightforward treatment” was prominent in the report's discussion of capital rules that could be addressed as part of regulatory relief.
The FDIC, OCC and Fed declined to comment for this article.
The current framework, which is part of Basel III, is said to place an expensive burden on banks. Loans designated as HVCRE are assigned a 150% risk weighting, meaning that banks must reserve $1.50 of capital for each $1 of lending, according to a September report by Jamie Watkins Bruno, a banking attorney at Williams Mullen. Traditional loans receive a 100% risk weighting, the report said.
Bankers also complain that it is hard to determine which loans merit HVCRE treatment, said David McCarthy, director of industry and policy at the council.
“The capital is burdensome, but it’s compounded by the confusion,” he said.
The legislation, introduced by Reps. Robert Pittenger, R-N.C., and David Scott, D-Ga., seeks to remove or clarify many of the confusing aspects of current law. These sore points include the required amount of cash that must be invested in a property and limits on loan-to-value ratios, said Bruce Oliver, an associate vice president at the Mortgage Bankers Association.
The measure would also clarify that a building that is mostly occupied, but may have one or two floors vacant due to renovation, should not be classified as HVCRE, Oliver said.
“Those loans are performing. The cash flows already cover the loan using normal underwriting standards,” Oliver said. “This [bill] would scoop out some of those loans which never should have been considered HVCRE.”
The bill’s sponsors and the industry “want to make the rules more accurately reflect the risk associated with these loans,” he said. “It’s about the dividing line between which things are higher risk and those that are not higher risk.”
However, it would not change the 150% risk-weighting for HVCRE loans, Oliver said.
Larger banks are better suited to hold higher amounts of HVCRE loans because they have the capital to absorb the hit, McCarthy said. That said, the level of exposure varies among bigger banks.
At the $63 billion-asset CIT Bank, almost 8% of its total loan book are HVCRE loans. But only 0.4% of Bank of America's loans are HVCRE.
Community and regional banks have a harder time taking the capital hit. In the fourth quarter of 2015, the total risk-based capital ratio at MVB Financial in Fairmont, W.Va., fell to 12.25% from 13% six months earlier. The $1.4 billion-asset company said the ratio declined largely because it had booked $22 million of new HVCRE loans in the quarter.
MVB has not updated the effects of HVCRE loans on its capital ratio since that time. Most banks do not discuss their HVCRE loans in regulatory filings, although they are required to break out their exposure in Federal Deposit Insurance Corp. call reports.
HVCRE loans can be a big slice of some community banks’ portfolios. The $1.9 billion-asset Live Oak Banking in Wilmington, N.C., held about $291 million of HVCRE loans at the end of the first quarter, about 19% of all its loans. At the $541 million-asset United Community Bank in Raceland, La., HVCRE loans totaled $150 million, or 35% of all loans. And Global Bank in New York tops the list with 80% of its loan book classified as HVCRE.
Yet some smaller banks can tolerate elevated HVCRE levels.
The $85 million-asset Dixon Bank in Kentucky has one of the highest percentages of HVCRE loans of any U.S. bank. Dixon held about $6 million of HVCRE loans and leases at March 31, about 29% of its loan book. But Dixon Bank is not running afoul of regulators, CEO Frank Ramsey said. Dixon’s Tier 1 capital ratio stood at 22%, which is enough to absorb the hit.
"The examiners were just in here, and they didn't say anything about it," Ramsey said. "We've got so much capital it doesn't bother them. It gives us leeway."
Ramsey said he was unaware of the legislation.
The House Financial Services Committee, which has been preoccupied with the Financial Choice Act, has not scheduled a hearing on the bill.