Excessive construction lending by banks and thrifts during the housing boom led to many failures and losses to the Federal Deposit Insurance Corp.
By yearend 2009, FDIC-insured institutions had $92 billion in single-family construction loans on their books and 25% of the loans were in various stages of delinquency and default. The net charge-off rate was 9.4% in the fourth quarter of 2009.
But acquisition, development and construction lending on commercial real estate was the real bank killer.
In cases where institutions had more than 100% of their risk-based capital tied up in CRE construction lending, 13% of those banks failed during the economic downturn from 2008 and 2011, according to a joint study by the Federal Reserve Board and the Office of the Comptroller of the Currency.
These findings seem to be reflected in the Basel III capital rule the Fed approved last week.
The regulators have raised the risk weighting to 150% for what they call “high-volatility” CRE construction loans, up from the current 100% risk weight.
However, the final risk-based capital rule preserves the current capital requirements for one-to-four family construction loans.
For home construction loans where the builder has a sales contract, the risk weight will remain at 50%. In cases where the builder is speculating that his newly constructed homes will sell, the risk weight is 100%.
It appears the federal regulators don’t want to make access to construction loans any harder than it already is. While the large publicly traded builders have easy access to capital, midsize and small builders are still struggling to get construction loans from their local banks.
The banking regulators also decided to keep the current Basel I risk-based capital requirements for residential lending in place. The Federal Reserve Board approved the final Basel III capital rule at a July 2 meeting. (Adoption by the FDIC and OCC is expected soon.)
The National Association of Home Builders seems pleased with the end result.
“We are pleased the regulators took some steps to ease the impact on community banks and their ability to lend to builders,” said NAHB vice president David Ledford.
He noted, however, that NAHB is still combing through the 970-page rule. “We still need to look over the entire document and assess its impact,” Ledford told NMN.
The Basel III capital rule does increase the overall capital requirements for FDIC-insured institutions and their holding companies. That is bound to have an impact on lending.
The final rule also creates a new “common equity Tier I capital” category and all banking originations will have to meet a common equity Tier I capital ratio of 4.5%.
Meanwhile, lenders are concerned that two cornerstones of the mortgage business—warehouse lending and servicing—are penalized under the new risk-based capital regime.
The provisions in the Basel III capital rule “addressing mortgage servicing rights and warehouse lines of credit are particularly problematic,” according to the Mortgage Bankers Association.
The regulators have decided to treat warehouse lines of credit as commercial credits, which will increase the amount of capital banks must hold against their warehouse lines.
The banking regulators have decided to exclude most mortgage servicing rights from the capital calculation by yearend 2018 when the phase-in of the Basel III capital requirements are slated to be complete.
The rule requires that MSRs, deferred tax assets and investments in unconsolidated financial institutions be limited individually to 10% and collectively to 15% of Tier I equity capital. MSRs that exceed the 10% or 15% thresholds must be deducted from capital.
“The Basel III final rule, when combined with the massive regulatory overhaul facing the real estate financial industry, will have the unfortunate effect of tightening credit, at a point in time when credit availability is one of the biggest challenges facing U.S. homebuyers,” said MBA president and CEO David Stevens.
