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FEDERAL RESERVE BANK OF NEW YORK [ Circular No. 10640 May 24, 1993 1 RISK-BASED CAPITAL G U ID E L IN E S Final R ule on C ertain R esidential C onstruction L oans E ffe c tiv e A p r il 2 6 , 1 9 9 3 To A l l S ta te M e m b e r B a n k s a n d B a n k H o ld in g C o m p a n ie s in th e S e c o n d F e d e r a l R e s e r v e D is tr ic t: In December 1992, the Board of Governors of the Federal Reserve System issued an interim rule that lowered from 100% to 50% the risk weight on certain residential construction loans (see our Circular No. 10610, dated January 7, 1993). Effective April 26, 1993, the Board made the rule final. Printed below is the text of the Board’s announcement: The Federal Reserve Board has issued a final rule amending the risk-based capital guidelines for State member banks and bank holding companies to lower from 100 to 50 percent the risk weight on loans to finance the construction of 1- to 4-fam ily residences that have been presold. The final rule amends the Board’s Regulation H and Regulation Y and is effective April 26, 1993, and implements section 618(a) of the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRIA). Printed on the following pages is the Board’s official notice of this action, as printed in the F e d e r a l R e g is te r of May 14. Questions on this matter may be directed to Manuel J. Schnaidman, Manager, Bank Analysis Department (Tel. No. 212-720-6710), or to Anne Wakelin of that Department (Tel. No. 212-720-6962). E. G erald C orrigan , P r e s id e n t. (RTCRRIA).1 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 FED ERAL RESER VE SYSTEM the buyer to purchase the property; 12 CFR Parts 208 and 225 (3) The purchaser provides to the builder a nonrefundable deposit in an [Regulations H and Y; D ocket No. R-0787] amount determined by the appropriate Federal banking agency, but not less Capital; Capital Adequacy Guidelines than 1 percent of the principal amount AGENCY: Board of Governors of the of the mortgage; and Federal Reserve System. (4) The loan satisfies prudent ACTION: Final rule. underwriting standards as established by the appropriate Federal banking SUMMARY: The Board of Governors of the agency. Federal Reserve System (Board or To comply with the legislation, the Federal Reserve) is adopting as a final Federal banking agencies, under the rule its interim rule amending the riskauspices of the Federal Financial based capital guidelines for bank Institutions Examination Council holding companies and state member (FFIEC), published for public comment, banks to lower from 100 percent to 50 on February 3,1992 (57 FR 4027), a percent the risk weight assigned to proposal expanding the definition of certain loans to builders to finance the loans secured by 1- to 4-family construction of presold residential (1- to residential properties contained in the 4-family) properties. This final rule Reports of Condition and Income for implements section 618(a) of the commercial banks (Call Report) to Resolution Trust Corporation encompass construction loans for Refinancing, Restructuring, and presold residential properties meeting Improvement Act of 1991. certain criteria. For state member banks, EFFECTIVE DATE: April 26,1993. the proposed definitional change would FOR FURTHER INFORMATION CONTACT: have resulted in lowering the risk Rhoger H Pugh, Assistant Director (202/ weight for construction loans for 728-5883), Norah M> Barger, Manager presold 1- to 4-family residential (202/452-2402), Robert E. Motyka, properties to 50 percent because the Supervisory Financial Analyst (202/452- Board’s guidelines reference the Call 3621), Barbara J. Bouchard, Senior Report definition in specifying the Financial Analyst (202/452-3072), appropriate capital treatment for 1- to 4Division of Banking Supervision and family residential property loans. Regulation, Board of Governors of the In response to the proposal to expand Federal Reserve System, 20th Street and the definition comments were received Constitution Avenue, NW., Washington, from forty-one public respondents. DC 20551. For the hearing impaired Thirty-two commenters agreed with the only, Telecommunication Device for the proposal. The nine commenters that Deaf (TDD), Dorothea Thompson (202/ opposed the FFIEC proposal did so on 452-3544). the grounds that the perceived reporting burden to implement the proposal did SUPPLEMENTARY INFORMATION: not justify the merits of the change. It Background was suggested that the Federal banking agencies implement the provisions of On December 12,1991, the Congress section 618(a) of RTCRRIA by amending enacted the Resolution Trust the risk-based capital guidelines rather Corporation Refinancing, Restructuring, than by changing the Call Report and Improvement Act of 1991 1 Pub. L 102-233,105 Stat. 1761. definition. This approach would make the application of die lower risk weight optional. After review of these comments and reconfirming agreement with the other Federal banking agencies, the Board issued, on December 30,1992 (57 FR 62177), an immediately effective interim rule amending the risk-based capital guidelines with a request for public comment. Under the interim rule, construction loans for presold 1- to 4family residential properties could be assigned to the 50 percent risk weight category if they conform to prudent underwriting standards including a conservative loan-to-value ratio; are performing in accordance with their original terms; and are not 90 days or more past due or carried in nonaccrual status. The notice further stated that the Board, after consultation and in agreement with the other banking agencies, would assign a 50 percent risk weight to such loans.only if the bank has met certain requirements including: documentation of the intent and ability of the buyer to purchase and occupy the home; evidence of at least 10 percent of the direct costs incurred by the builder; and, an earnest money deposit from the purchaser of at least 3 percent of the purchase price held in escrow to first defray costs incurred by the lender in the event of default. The interim rule was made effective immediately to permit state member banks and bank holding companies to take immediate advantage of a lower risk weight for qualifying construction loans for presold residential properties. Comments Received In response to the interim rule request for comment, responses were received from twelve public commenters: nine banking institutions and three trade associations. Ten of the twelve respondents agreed that construction loans for presold 1- to 4-family residential properties should be assigned to the 50 percent risk category if certain criteria are met. Three commenters based their support for the amendment on what they viewed as the inherent low risk associated with these types of construction loans for presold properties. Several commenters noted their approval of an amendment to the guidelines as opposed to a definitional change in the Call Report. The one commenter that disagreed with the the home (i.e., has a firm written commitment for permanent financing of the home upon completion), and when 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 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. (C) The purchaser has made a substantial “earnest money deposit” of no less than 3 percent of the residence’s sales price ana 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 third party in a fiduciary capacity and the Based upon discussions with the escrow agreement must provide that, in other Federal banking agencies and the the event of default arising from the public comments received, the Board is cancellation of the sales contract by the adopting in final form its interim rule buyer, the escrow funds must first be amending the risk-based capital applied for and used to defray any costs guidelines for state member banks and incurred by the lending bank. bank holding companies to state that Furthermore, in the case of 1- to 4loans secured by 1- to 4-family family residences in multiple home residential properties eligible for the 50 projects such as townhouses and percent risk category for risk-based condominiums under a master-note capital purposes include “loans to where all of the units have not been builders with substantial project equity presold, banks are permitted to apply the preferential 50 percent risk weight for the construction of 1- to 4-family residences that have been presold under to that portion of the loan representing presold units while assigning the firm contracts to purchasers who have portion representing unsold units to the obtained firm commitments for 100 percent risk category. Additionally, permanent qualifying mortgage loans the Board notes that prudent and have made substantial earnest underwriting standards require that, money deposits.” Presold residential construction loans may be placed in the although there are no specified time 50 percent risk category if they conform limitations between the extension of the loan and the actual start of construction, to prudent underwriting standards banks should ensure that construction including a conservative loan-to-value ratio; are performing in accordance with begins within a reasonable amount of their original terms; and are not 90 days time after disbursement of funds. or more past due or carried in Regulatory Flexibility Act Analysis nonaccrual status. In addition, as stated The Federal Reserve Board does not in the interim rule, the Board, in believe that adoption of this final rule agreement with the other Federal would have a significant economic banking agencies, will expect impact on a substantial number of small institutions to apply a 50 percent risk business entities in accord with the weight to loans to builders for 1- to 4family residential property construction spirit and purposes of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.). In only when the bank has obtained sufficient documentation that the buyer that regard, the final rule would reduce certain regulatory burdens on bank of the home intends to purchase the home (i.e., has a legally binding written holding companies. In addition, because the risk-based and leverage capital sales contract), has the ability to obtain guidelines generally do not apply to a mortgage loan sufficient to purchase interim rule expressed the view that such construction loans are risky and, hence, a preferential risk weight was not justified. One commenter offered no overall opinion. Commenters requested clarification on several issues. These included: whether any time restraints between the extension of the construction loan and the actual start of construction would be applied; the practicality of requiring a builder to fund at least the first 10 percent of the direct costs; clarification as to what could be included in the calculation of total direct costs; whether the earnest money requirements could be reduced or altered so as to allow builders the use of earnest money where permissible by law and to provide some protection to the builder through the return of excess earnest money funds in the event of default by the buyer; and, whether the portion of a construction loan extended under a master-note agreement for a multiple home project that represents presold units could be assigned a 50 percent risk weight. Final Rule 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, Agricultural loan losses, Applications. Appraisals, Banks, banking, Branches, Capital adequacy, Confidential business information, Currency, Dividend payments, Flood insurance. Publication of reports of condition, Reporting and recordkeeping requirements, Securities, State member banks. 12 CFR Part 225 Administrative practice and procedure, Appraisals, Banks, banking, Capital adequacy, Holding companies, Reporting and recordkeeping requirements, Securities, State member banks. For the reasons set forth in the preamble, and pursuant to the Board’s authority under 12 U.S.C. 1844(b) and 3909, the interim rule amending 12 CFR part 208, appendix A and 12 CFR part 225, appendix A published at 57 FR 62177 on December 30,1992, is adopted by the Board as a final rule without change. Board o f G overnors o f the Federal Reserve S y stem , M ay 1 0 ,1 9 9 3 . William W. Wiles, Secretary o f the Board. [FR Doc. 9 3 -1 1 5 0 0 F iled 5 - 1 3 -9 3 ^ 8 :4 5 am] BILLING CODE #210-01- f
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