I. INTRODUCTION
Each of the federal banking regulators joined together to issue uniform real estate lending standards which became effective March 19, 1993. These standards were established pursuant to Section 304 of the FDIC Improvement Act of 1991.
The uniform regulations require each insured depository institution to adopt and maintain comprehensive written real estate loan policies that are consistent with safe and sound banking practices.
Under the regulations, a bank must adopt and maintain a written policy that establishes appropriate limits and standards for all extensions of credit that are secured by liens on or interests in real estate or made for the purpose of financing the construction of a building or other improvements, regardless of whether a lien has been taken on the property.
II. FORMULATING LOAN POLICY
A bank’s real estate loan policy is required to be (a) comprehensive; (b) consistent with safe and sound lending practices; and (c) sufficient to ensure that the bank operates within limits and according to standards that are reviewed and approved at least annually by the bank’s board of directors.
The bank’s real estate lending policy should contain a general outline of the scope and distribution of the institution’s credit facilities and the manner in which real estate loans are made, serviced and collected. In particular, the institution’s policies on real estate lending should:
1. Identify the geographic areas in which the institutions will consider lending;
2. Establish a loan portfolio diversification policy and set limits for real estate loans by type and geographic market (e.g., limits on higher risk loans);
3. Identify appropriate terms and conditions by type of real estate loan;
4. Establish loan origination and approval procedures, both generally and by size and type of loan;
5. Establish prudent underwriting standards that are clear and measurable, including loan-to-value limits, that are consistent with these supervisory guidelines;
6. Establish review and approval procedures for exception loans, including loans with loan-to-value percentages in excess of supervisory limits;
7. Establish loan administration procedures, including documentation, disbursement, collateral inspection, collection, and loan review;
8. Establish real estate appraisal and evaluation programs; and
9. Require that management monitor the loan portfolio and provide timely and adequate reports to the board of directors.
The bank should consider both internal and external factors in the formulation of its real estate loan policy which, at a minimum, should include the following:
1. The size and financial condition of the institution;
2. The expertise and size of the lending staff;
3. The need to avoid undue concentrations of risk;
4. Compliance with all real estate related laws and regulations, including the Community Reinvestment Act, and anti-discrimination laws; and
5. Market conditions.
The bank should monitor conditions in the real estate markets in its lending area so that it can react quickly to changes in market conditions that are relevant to its lending decisions. In evaluating market conditions, the guidelines suggest the following items should be monitored and considered in policy formulation:
1. Demographic indicators, including population and employment trends;
2. Zoning requirements;
3. Current and projected vacancy, construction, and absorption rates;
4. Current and projected lease terms, rental rates, and sales prices, including concessions;
5. Current and projected operating expenses for different types of projects;
6. Economic indicators, including trends and diversification of the lending area; and
7. Valuation trends, including discount and direct capitalization rates.
III. UNDERWRITING STANDARDS
In establishing underwriting standards, all relevant credit factors, should be considered, including:
1. The capacity of the borrower, or income from the underlying property, to adequately service the debt;
2. The value of the mortgaged property;
3. The overall creditworthiness of the borrower;
4. The level of equity invested in the property;
5. Any secondary sources of repayment; and
6. Any additional collateral or credit enhancements (such as guarantees, mortgage insurance or takeout commitments).
The bank’s lending policy must also reflect the level of risk that is acceptable to the board of directors and provide clear and measurable underwriting standards that enable the bank’s lending staff to evaluate these credit factors. In addition to credit underwriting standards, for all real estate loans, the bank’s lending policy should address:
1. The maximum loan amount by type of property;
2. Maximum loan maturities by type of property;
3. Amortization schedules;
4. Pricing structure for different types of real estate loans; and
5. Loan-to-value limits by type of property.
For all development and construction projects, and loans on completed commercial properties, the bank’s lending policy should also establish, commensurate with the size and type of the project or property, or the following:
1. Requirements for feasibility studies and sensitivity and risk analyses (e.g., sensitivity of income projections to changes in economic variables such as interest rates, vacancy rates, or operating expenses);
2. Minimum requirements for initial investment and maintenance of hard equity by the borrower (e.g., cash or unencumbered investment in the underlying property);
3. Minimum standards for net worth, cash flow, and debt service coverage of the borrower or underlying property;
4. Standards for the acceptability of and limits on non-amortizing loans;
5. Standards for the acceptability of and limits on the use of interest reserves;
6. Standards for the acceptability of and limits on the use of interest reserves;
7. Pre-leasing and pre-sale requirements for income- producing property;
8. Pre-sale and minimum unit release requirements for non-income-producing property loans;
9. Limits on partial recourse or nonrecourse loans and requirements for guarantor support;
10. Requirements for takeout commitments; and
11. Minimum covenants for loan agreements.
IV. LOAN ADMINISTRATION PROCEDURES
The real estate lending standards require a bank’s loan policy to include procedures for loan administration. The regulation contemplates loan administration to include everything that occurs between the time a loan application is approved until the loan is satisfied. Accordingly, the bank’s lending policy must also address the following:
1. Documentation, including: (a) type and frequency of financial statements, including requirements of verification of information provided by the borrower and (b) type and frequency of collateral evaluations (appraisals and other estimates of value).
2. Loan closing and disbursement.
3. Payment processing.
4. Escrow administration.
5. Collateral administration.
6. Loan payoffs.
7. Collection and foreclosure, including: (a) delinquency follow-up procedures;(b) foreclosure timing; (c) extensions and other forms of forbearance; (d) acceptance of deeds in lieu of foreclosure; (e) claims processing (e.g., seeking recovery on a defaulted loan covered by a government guaranty or insurance program); and (f) servicing and participation agreements.
V. SUPERVISORY LOAN-TO-VALUE LIMITS
While the bank should establish its own internal loan-to-value limits for real estate loans, these internal limits may not exceed the following supervisory limits:
Loan Category
Loan-to-Value Limit
Raw land............................................................................................. Land Development................................................................................ Construction: Commercial, multifamily and other nonresidential................ One-to-four family residential................................................................. Improved property................................................................................. Owner-occupied one-to-four family and home equity.................................
65% 75% 80% 85% 85% 90%*
* Loans can exceed 90% loan-to-value with credit enhancement in the form of mortgage insurance or readily marketable collateral.
VI. ESTABLISHING LOAN-TO-VALUE RATIO LIMITS
In establishing internal loan-to-value limits, a bank is expected to carefully consider the institution-specific and market factors listed under the “Formulating Loan Policy”, section above, as well as any other relevant factors, such as the particular subcategory or type of loan. For any subcategory of loans that exhibits greater credit risk than the overall category, a bank should consider the establishment of an internal loan-to-value limit for that subcategory that is lower than the limit for the overall category.
The loan-to-value ratio is only one of several pertinent credit factors to be considered when underwriting a real estate loan. Other credit factors to be taken into account are highlighted in the “Underwriting Standards” section above. Because of these other factors, the establishment of these supervisory limits should not be interpreted to mean that loans at these levels will automatically be considered sound.
The supervisory maximum loan-to-value ratio limits establish the maximum ratios that any bank, under any conditions may establish as policy for loan-to-value ratios. A bank should fully realize that the maximum ratios establish the maximum loan allowable under the best of circumstances and conditions. Only under the most favorable conditions should a bank consider adopting the regulatory maximum as its internal loan-to-value ratio for any category of real estate.
The loan to value ratios established by a bank under its loan policy should not represent the maximum amount that the bank will ever accept, but should set the standard for the normal situation. As set forth below, the regulation allows loans in excess of supervisory limits under specific circumstances.
VII. LOANS IN EXCESS OF SUPERVISORY STANDARDS
The guidelines recognize that it may be appropriate in individual cases to originate or purchase loans with a loan-to-value ratio in excess of the supervisory loan-to-value limits, if the loan is based on support provided by other credit factors. Such loans should be identified in the institution’s records, and their aggregate amount reported at least quarterly to the institution’s board of directors.
The aggregate amount of all loans in excess of the supervisory loan-to-value limits should not exceed 100 percent of the total risk-based capital of the institution, and, within that aggregate limit, total loans for all commercial, agricultural, multifamily or other non-1-to-4 family residential properties should not exceed 30 percent of total risk-based capital. An institution will come under increased supervisory scrutiny as the total of such loans approaches these levels.
In determining the aggregate amount of such loans, institutions should: (a) Include all loans secured by the same property if any one of those loans exceeds the supervisory loan-to-value limits; and (b) include the recourse obligation of any such loan sold with recourse. Conversely, a loan should no longer be reported to the board of directors as part of the aggregate totals when reduction in principal or senior liens, or additional contribution of collateral or equity (e.g., improvements to the real property securing the loan) bring the loan-to-value ratio into compliance with supervisory limits.
VIII. EXCLUDED TRANSACTIONS
The guidelines provide a non-exclusive list of lending situations in which other factors significantly outweigh the need to apply the supervisory loan-to-value limits. Included among the exceptions are the following:
1. Loans guaranteed or insured by the U.S. government or its agencies, provided that the amount of the guaranty or insurance is at least equal to the portion of the loan that exceeds the supervisory loan-to-value limit;
2. Loans backed by the full faith and credit of a state government, provided that the amount of the assurance is at least equal to the portion of the loan that exceeds the supervisory loan-to-value limit;
3. Loans guaranteed or insured by a state, municipal or local government, or an agency thereof, provided that the amount of the guaranty or insurance is at least equal to the portion of the loan that exceeds the supervisory loan-to-value limit, and provided that the lender has determined that the guarantor or insurer has the financial capacity and willingness to perform under the terms of the guaranty or insurance agreement;
4. Loans that are to be sold promptly after origination, without recourse, to a financially responsible third party;
5. Loans that are renewed, refinanced, or restructured without the advancement of new funds or an increase in the line of credit (except for reasonable closing costs), or loans that are renewed, refinanced, or restructured in connection with a workout situation, either with or without the advancement of new funds, where consistent with safe and sound banking practices and part of a clearly defined and well-documented program to achieve orderly liquidation of the debt, reduce risk of loss, or maximize recovery on the loan;
6. Loans that facilitate the sale of real estate acquired by the lender in the ordinary course of collecting a debt previously contracted in good faith;
7. Loans for which a lien on or interest in real property is taken as additional collateral through an abundance of caution by the lender (e.g., the institution takes a blanket lien on all or substantially all of the assets of the borrower, and the value of the real property is low relative to the aggregate value of all other collateral);
8. Loans, such as working capital loans, where the lender does not rely principally on real estate as security and the extension of credit is not used to acquire, develop, or construct permanent improvements on real property; and
9. Loans for the purpose of financing permanent improvements to real property, but not secured by the property, if such security interest is not required by prudent underwriting practice.
IX. EXCEPTIONS TO THE GENERAL LENDING POLICY
The guidelines recognize that a bank may receive loan requests from creditworthy borrowers whose credit needs do not fit within the institution’s general lending policy. An institution may provide for prudently underwritten exceptions to its lending policies, including loan-to-value limits, on a loan-by-loan basis. However, any exceptions from the supervisory loan-to-value limits should conform to the aggregate limits on such loans discussed above.
In establishing exceptions to the banks general lending policy, the board of directors is responsible for establishing standards for the review and approval of exception loans. Each bank should establish an appropriate internal process for the review and approval of loans that do not conform to its own internal policy standards. The approval of any such loan should be supported by a written justification that clearly sets forth all of the relevant credit factors that support the underwriting decision. The justification and approval documents for such loans should be maintained as a part of the permanent loan file, and all exception loans of a significant size should be individually reported to the board of directors of the bank.
X. MONITORING COMPLIANCE WITH LOAN STANDARDS
In order to ensure that the bank’s practices conform to its stated loan policy and the supervisory standards, a bank must establish monitoring procedures. As noted above, the bank’s board of directors must establish standards and procedures for the review and approval of loans that do not meet bank lending policy requirements and also for loans that do not meet supervisory standards.
In evaluating the bank real estate lending policies, examiners will be determining if the bank policy is consistent with safe and sound lending practices, the terms of these guidelines and the requirements of the regulation and will take into consideration the following factors:
1. The nature and scope of the bank’s real estate lending activities.
2. The size and financial condition of the institution.
3. The quality of the institution’s management and internal controls.
4. The expertise and size of the lending and loan administration staff.
XI. CONCLUSION
In complying with the real estate lending standards, each bank should analyze existing policies and make appropriate changes to be in conformance with the new standards.