Banks face higher reserves for some lot development loans

Dive Brief:

Banks will have to hold 12% of a loan amount in reserve when lending to developers looking to improve vacant land for eventual construction of up to four units of residential housing, regulators proposed in a rule released Monday.
The rule clarifies a question banks have had for several years about what kind of lot development would qualify for an exemption to the 12% reserve requirement.
The reserve requirement was enacted in 2015 to implement international capital standards under Basel III. The 12% requirement applies to commercial real estate loans that are considered exposed to "high velocity" risk. The previous reserve requirement was 8%. By increasing it to 12%, the reserve requirement amounts to 150% risk-weighted coverage of potential losses. Commercial real estate lenders have said the higher reserve requirements make the loans less attractive to make, and regulators have acknowledged that lenders will likely make fewer loans as a result.

Dive Insight:

Under Monday's proposed rule, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. clarify that the higher reserve requirement does not apply to loans to develop lots for up to four units of housing if the project includes the actual construction of the homes.

If the loan is only for preparing the lot for development by financing pre-construction work like laying the sewers and water pipes, the loan doesn't qualify for the exemption. "Supervisors generally consider land development loans to present elevated risk as compared to construction loans," regulators said in the preamble to the rule.

"Land development loans may be made for speculative purposes, generate no cash flow, and require other sources of cash to service the debt. Based on the risks arising from land development loans, the agencies believe it would be imprudent to include loans that solely finance land development to prepare it for erecting new structures as part of the one- to four-family residential properties exclusion from the HVCRE [high velocity commercial real estate] exposure definition."

The regulators are asking bankers and others involved in commercial real estate lending and development to weigh in on its proposal to attach the higher reserve requirement to the development loans. Comments are being accepted for 30 days after publication.