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Federal Reserve Bank
OF DALLAS
ROBERT

D. M c T E E R , J R .

P R E S ID E N T
AND

C H IE F

E X E C U T IV E

O F F IC E R

January 7, 1993

DALLAS, TEXAS 75222

Notice 93-04
TO:

The Chief Executive Officer of each
member bank and others concerned in
the Eleventh Federal Reserve District
SUBJECT
Interim Rule and Request for Comments on
Risk-based Capital Guidelines
DETAILS

The Federal Reserve Board has issued an interim rule amending the
risk-based capital guidelines for state member banks and holding companies to
lower from 100 to 50 percent the risk weight on loans to finance the construc­
tion of 1- to 4-family residences that have been presold.
The interim rule, which became effective December 29, 1992, amends
the B o a r d ’s Regulation H and Regulation Y and will be reviewed by the Board
after the receipt of public comment. The interim rule implements section 618
(a) of the Resolution Trust Corporation Refinancing, Restructuring, and
Improvement Act of 1991 (RTCRRIA).
The Board must receive comments by January 27, 1993.
Comments
should be addressed to William W. Wiles, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington,
D.C. 20551. All comments should refer to Docket No. R-0787.
ATTACHMENT
A copy of the Bo a r d ’s notice (Federal Reserve System Docket No.
R-0787) is attached.
MORE INFORMATION
For more information, please contact Dorsey Davis at (214) 922-6051.
For additional copies of this B a n k ’s notice, please contact the Public Affairs
Department at (214) 922-5254.
Sincerely yours,

'fiW ' B

.

.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal Reserve Bank of Dallas:
Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston Branch Intrastate (800) 392-4162,
Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0787]
Capital; Capital Adequacy Guidelines
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Interim rule with request for comments.
SUMMARY: The Federal Reserve is amending its risk-based capital guidelines to

lower from 100 percent to 50 percent the risk weight assigned to certain loans
to builders to finance the construction of presold residential (1- to 4-family)
properties. This interim rule implements section 618(a) of the Resolution Trust
Corporation Refinancing, Restructuring, and Improvement Act of 1991
(RTCRRIA). In February 1992, the Federal Reserve, under the auspices of the
Federal Financial Institutions Examination Council (FFIEC), sought public
comment on a proposal to implement section 618(a) of RTCRRIA through a
change to the commercial bank Consolidated Reports of Condition and Income
(Call Report). It was suggested in the comments that section 618(a) of the
RTCRRIA be implemented through an amendment to the Federal banking
agencies’ risk-based capital rules and guidelines instead of to the Call Report.
The Board has determined to adopt this suggestion as an alternative to the original
proposal. The Board has adopted this change to the risk-based capital guidelines
on an interim basis in order to provide interested parties an opportunity to
comment on this approach.
EFFECTIVE DATE: This interim rule is effective as of December 29, 1992.

Comments must be received by January 27, 1993.
ADDRESSES: Comments should be addressed to Mr. William Wiles, Secretary

of the Board, Board of Governors of the Federal Reserve System, 20th and
Constitution Avenue NW., Washington, DC 20551, or delivered to room B-2223,
Eccles Building, between 8:45 am and 5 pm. Comments may be inspected in
room B -l 122 between 9 am and 5 pm, except as provided in § 261.8 of the
Board’s Rules Regarding Availability of Information, 12 CFR 261.8.
FOR FURTHER INFORMATION CONTACT: Rhoger H. Pugh, Assistant Director (202/
728-5883), Norah M. Barger, Manager (202/452-2402), and Robert E. Motyka,
Senior Financial Analyst (202/452-3621), Division of Banking Supervision and
Regulation, Board of Governors of the Federal Reserve System. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), Dorothea
Thompson (202/452-3544), Board of Governors of the Federal Reserve System,
20th and C Streets, NW., Washington, DC 20551.
SUPPLEMENTARY INFORMATION:

2
Background
The international bank capital standards (Basle Accord)1 place all assets into
the 100 percent risk category unless the asset specifically qualifies for a
preferential risk category. In this regard, the Accord allows member countries
at their discretion to assign a 50 percent risk weight to loans secured by
residential property provided that such loans are fully secured by mortgages on
residential property that is rented or is occupied (or is intended to be occupied)
by the borrower and the risk weight is applied in accordance with strict prudential
criteria. The U.S. risk-based capital guidelines, which implement the Basle
Accord, assign 1- to 4-family residential mortgages that meet certain criteria to
the 50 percent risk category. In order to qualify for a 50 percent risk weight,
a loan secured by a 1- to 4-family residential property must be a first lien; must
be made in accordance with prudent underwriting standards, including a
conservative loan-to-value ratio; must be performing in accordance with its
original terms; and must not be more than 90 days past due or carried in
nonaccrual status. The U.S. risk-based capital guidelines assign loans to builders
to finance the construction of residential properties that have been presold to
purchasers who intend to occupy the property to the 100 percent risk category
on the basis of the perceived inherent riskiness of these loans. Under the Basle
Accord such loans could, at national discretion, be assigned a 50 percent risk
weight.
After the risk-based capital guidelines were adopted, the Federal Reserve
along with the Office of the Comptroller of the Currency (OCC), the Federal
Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision
(OTS) reexamined the issue of the capital treatment of residential mortgages.
Specifically, the banking agencies considered the appropriateness of applying a
50 percent risk weight to certain loans to builders to finance the construction
of residential properties that have been presold to qualifying individuals.
Before the agencies proceeded with a proposal, Congress enacted the
RTCRRIA on December 12, 1991. Section 618(a) of the Act requires the Federal
banking agencies to provide for a risk weight of 50 percent in their regulations
and guidelines for any single family residential construction loan that meets the
following criteria:
(1) The loan is for the construction of 1- to 4-family residential property;
(2) The bank has sufficient documentation, as may be required by the
appropriate Federal banking agency, to demonstrate the intent and ability of the
buyer to purchase the property;

1
The Basle Accord is a risk-based capital framework that was proposed by the Basle
Committee on Banking Regulations and Supervisory Practices and endorsed by the central bank
governors o f the Group o f Ten (G-10) countries in July 1988. The Committee is comprised
o f representatives o f the central banks and supervisory authorities from the G-10 countries
(Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the United
Kingdom, and the United States) and Luxembourg.

3
(3) The purchaser provides to the builder a nonrefundable deposit in an
amount determined by the appropriate Federal banking agency, but not less than
1 percent of the principal amount of the mortgage; and
(4) The loan satisfies prudent underwriting standards as established by the
appropriate Federal banking agency.
In order to effect a lower risk weight for these loans in conformance with
the legislation, the agencies decided to propose expanding the definition of loans
“ secured by 1- to 4-family residential properties” contained in the commercial
bank Call Report to include presold residential construction loans that meet
certain criteria. In this regard, the FFTEC published for comment on February
3, 1992, a proposal to add to the list of loans that are secured by 1- to 4-family
residential properties, and exclude from the list of loans made for the purpose
of construction and land development, loans that are “ made in accordance with
sound lending principles to builders with substantial project equity for the
construction of 1- to 4-family residences that have been presold under firm
contracts to purchasers who have obtained firm commitments for permanent
qualifying mortgage loans and have made substantial earnest money deposits.”
For the Federal Reserve and the FDIC, the proposed definitional change
would have resulted in lowering the risk weight for presold 1- to 4-family
residential construction loans because these agencies’ risk-based capital
guidelines assign loans that meet the Call Report definition of 1- to 4-family
residential mortgages to the 50 percent risk category. The definitional change
would have had no effect on the risk weight for presold residential construction
loans held by national banks or thrifts since neither the OCC’s nor the OTS’s
risk-based capital rules reference the Call Report definition for loans secured by
1- to 4-family residential properties. As a result, both the OCC and OTS were
required to amend their risk-based capital rules to effect the lower risk weight.
The OTS amendment became effective May 13, 1992, while the OCC amendment
became effective October 5, 1992.
Once a final version of the Call Report change was agreed to, the Federal
Reserve intended to make conforming changes to the Consolidated Financial
Statements for Bank Holding Companies (Y-9C Report).
Comments Received
Comments were received from 41 public respondents. These included one
multinational, one regional, and twenty-nine community banking organizations;
one thrift association; one government-sponsored entity; seven trade associations;
and one member of the public. Overall, 32 commenters, or approximately 78
percent of the total respondents, agreed with the proposal. They expressed the
view that the definitional change and reassignment of these loans to a lower
risk category was fair and consistent with the riskiness inherent in these types
of residential real estate loans.
The nine commenters that opposed the FFIEC’s proposal did so on the
grounds that, in their view, the perceived reporting burden to implement the
proposal did not justify the merits of the outcome. One of these commenters

4
stated it would agree with the proposal if the Call Report change would be
optional.
It was suggested in the comments that the Federal Reserve implement the
provisions of section 618(a) of the RTCRRIA by amending the risk-based capital
guidelines rather than by changing the definition of loans secured by 1- to 4family residential properties contained in the Call Report. One commenter, the
multinational banking organization, noted that this approach would be more
appropriate and much simpler for banking organizations to implement than a
regulatory reporting change.
The FF1EC proposal requested specific comment on builder equity and
purchaser earnest money standards, “ including the most appropriate way to
define and compute a builder’s project equity and the percentages or amounts
of builder equity and purchaser earnest money that should be at risk.” Eleven
comment letters suggested definitions and amounts for “ builder equity” and
“ purchaser earnest money deposit.” The amounts suggested for builder’s equity
ranged from 10 percent to 75 percent of the contract price. In addition, a number
of commenters offered specific suggestions on what that percentage should be
based on, such as cost of land acquisition or hard costs of construction. Suggested
amounts for substantial earnest money deposits ranged from 1 percent to 20
percent.
Amendment To The Risk-Based Capital Guidelines
Based upon discussions with the other Federal banking agencies and the
public comments received, the Board is amending the risk-based capital
guidelines for state member banks and bank holding companies to state that loans
secured by 1- to 4-family residential properties eligible for the 50 percent risk
category for risk-based capital purposes include “ loans to builders with
substantial project equity for the construction of 1- to 4-family residences that
have been presold under firm contracts to purchasers who have obtained firm
commitments for permanent qualifying mortgage loans and have made substantial
earnest money deposits.” In order to be assigned a 50 percent risk weight, such
loans, like other loans for 1- to 4-family residences, would have to be made
in accordance with prudent underwriting standards, including a conservative loanto-value ratio; to be performing in accordance with their original terms; and to
not be 90 days or more past due or carried in nonaccrual status. This change
to the risk-based capital guidelines would have the effect of including in the
50 percent risk category presold residential construction loans that RTCRRIA
requires to be included in this category.
The Board notes that the statute specifies that the agencies may establish
prudent underwriting standards for presold 1- to 4-family residential construction
loans accorded a 50 percent risk weight. In this regard, the agencies expect that
institutions will apply a 50 percent risk weight to loans to builders for 1- to
4-family residential property construction only if the bank has obtained sufficient
documentation that the buyer of the home intends to purchase the home (i.e.,
has a legally binding written sales contract) and has the ability to obtain a
mortgage loan sufficient to purchase the home (i.e., has a firm written

5
commitment for permanent financing of the home upon completion), so long as
the following additional criteria are met:
(A) The purchaser is an individual(s) who intends to occupy the residence
and is not a partnership, joint venture, trust corporation, or any other entity
(including an entity acting as a sole proprietorship) that is purchasing one or
more of the homes for speculative purposes.
(B) The builder must incur at least the first 10 percent of the direct costs
(i.e., actual costs of the land, labor, and material) before any drawdown is made
under the construction loan and the construction loan may not exceed 80 percent
of the sales price of the presold home.2
(C) The purchaser has made a substantial “ earnest money deposit” of no
less than 3 percent of the residence’s sales price and that deposit must be subject
to forfeiture if the purchaser terminates the sales contract.
(D) The earnest money deposit must be held in escrow by the bank financing
the builder or by an independent party in a fiduciary capacity and the escrow
agreement must provide that, in the event of default arising from the cancellation
of the sales contract by the buyer, the escrow funds must first be used to defray
any costs incurred by the lending bank.
Section 618(a) requires the agencies to take action within 120 days of
enactment of the RTCRRIA to permit the different capital treatment of the type
of housing loans discussed above. As suggested in the comments received, the
Board has decided to implement section 618(a) by adopting revisions to the riskbased capital guidelines directly rather than changing the Call Report and Y9C Report provisions. The effect on the calculation of capital for state member
banks and bank holding companies of amending the guidelines is substantially
the same as the effect of revising the Call Report and the Y-9C Report, and
will satisfy the requirements of section 618(a). The Board adopted the change
to the risk-based capital guidelines as an interim rule, rather than a final rule,
however, in order to provide interested parties an opportunity to comment on
this alternative approach. The adoption of an interim rule will permit state
member banks and bank holding companies to take advantage of a lower risk
weight for presold residential construction loans effective immediately. The
Board will revise the rule as required to address comments received during the
thirty-day comment period.
2
Under the agencies’ 1992 real estate underwriting standards regulation and guidelines,
as a general matter, institutions may extend loans for the construction o f 1- to 4-family
residences with loan-to-value ratios (LTV) of up to 85 percent. These guidelines, which
implement section 304 of the Federal Deposit Insurance Corporation Improvement Act of 1991,
become effective on March 19,1993. While these guidelines permit institutions to make presold
residential construction loans with LTV ratios that exceed 80 percent, such loans would not
qualify for the 50 percent risk category. Rather, they should be assigned to the 100 percent
risk category.

6
Regulatory Flexibility Act Analysis
The Federal Reserve Board does not believe that adoption of this amendment
would have a significant economic impact on a substantial number of small
business entities in accord with the spirit and purposes of the Regulatory
Flexibility Act (5 U.S.C. 601 et seq.) In that regard, the amendment would reduce
certain regulatory burdens on bank holding companies. In addition, because the
risk-based and leverage capital guidelines generally do not apply to bank holding
companies with consolidated assets of less than $150 million, this amendment
will not affect such companies.
List of Subjects
12 CFR Part 208
Accounting, Agriculture, Banks, banking, Confidential business information,
Currency, Federal Reserve System, Reporting and recordkeeping requirements,
Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal Reserve
System, Holding companies, Reporting and recordkeeping requirements,
Securities.
For the reasons set forth in the preamble, and pursuant to the Board’s
authority under section 5(b) of the Bank Holding Company Act of 1956 (12
U.S.C. 1844(b)), and section 910 of the International Lending Supervision Act
of 1983 (12 U.S.C. 3909), the Board is amending 12 CFR parts 208 and 225
as follows:

PART 208—MEMBERSHIP OF STATE BANKING INSTITUTIONS IN
THE FEDERAL RESERVE SYSTEM
1. The authority citation for part 208 is revised to read as follows:
Authority: Sections 9, 11(a), 11(c), 19, 21, 25, and 25(a) of the Federal Reserve
Act, as amended (12 U.S.C. 321-338, 248(a), 248(c), 461, 481-486, 601, and 611,
respectively); sections 4 and 13(j) of the Federal Deposit Insurance Act, as amended
(12 U.S.C. 1814 and 1823(j), respectively); section 7(a) of the International Banking
Act of 1978 (12 U.S.C. 3105); sections 907-910 of the International Lending
Supervision Act of 1983 (12 U.S.C. 3906-3909); sections 2, 12(b), 12(g), 12(i), 15B(c)
(5), 17, 17A, and 23 of the Securities Exchange Act of 1934 (15 U.S.C. 78b, 78/(b),
78/(g), 78/(i), 78o-4(c) (5), 78q, 78q-l, and 78w, respectively); section 5155 of the
Revised Statutes (12 U.S.C. 36) as amended by the McFadden Act of 1927; and sections
1101-1122 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989
(12 U.S.C. 3310 and 3331-3351); 12 U.S.C. 93a, 161, 1818, 3907, 3909, Sec. 618,
Pub. L. 102-233, 105 Stat. 1761 (Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991).
2. Appendix A to part 208 is amended by revising footnote 35 to read as
follows:

APPENDIX A TO PART 208—[Amended]
*
*
*
*
*
HI. Procedures for Computing Weighted-Risk Assets and Off-Balance-Sheet Items
*

*

*

*

*

C. Risk Weights
*

*
3

*

*

*

***3 5

35 Loans that qualify as loans secured by one- to four-family residential properties
are listed in the instructions to the commercial bank call report. In addition, for riskbased capital purposes, loans secured by one- to four-family residential properties
include loans to builders with substantial project equity for the construction of oneto four-family residences that have been presold under firm contracts to purchasers who
have obtained firm commitments for permanent qualifying mortgage loans and have
made substantial earnest money deposits.

PART 225— BANK HOLDING COMPANIES AND CHANGE IN BANK
CONTROL
1. The authority citation for part 225 is revised to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1831i, 1843(c)(8), 1844(b), 3106, 3108,
3907, 3909, 3310, and 33313351.
2. Appendix A to Part 225 is amended by revising footnote 38 to read as follows:
APPENDIX A TO PART 225 - [Amended]
*

*

*

*

*

m. PROCEDURES FOR COMPUTING WEIGHTED-RISK ASSETS AND OFFBALANCE-SHEET ITEMS
*
*
*
*
*
C. Risk Weights
*

*

*

*

*

3. ***38
38 Loans that qualify as loans secured by one- to four-family residential properties
are listed in the instructions to the FR Y-9C Report. In addition, for risk-based capital
purposes, loans secured by one- to four-family residential properties include loans to
builders with substantial project equity for the construction of one- to four-family
residences that have been presold under firm contracts to purchasers who have obtained
firm commitments for permanent qualifying mortgage loans and have made substantial
earnest money deposits.
Board of Governors of the Federal Reserve System, December 22, 1992.

William W. Wiles,
Secretary of the Board.
[FR Doc. 92-00000 Filed 00-00-92; 8:45 am]
BILLING CODE 6210-01 -F


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102