Credit Standards on AD&C Construction Lending: A Tale of Two Sectors

According to NAHB’s Survey on Acquisition, Development & Construction Financing, residential real estate builders and developers reported that credit conditions for acquisition, development, and single-family construction (AD&C) loans were easier in the second quarter of 2016 than in the first quarter of 2016. Hence the NAHB net tightening index dropped from its level in the first quarter.


Following 5 consecutive quarterly declines in the pace of net easing, more respondents on net, 25.0%, reported that credit standards on AD&C financing had eased in the second quarter of 2016 from the first quarter. In the first quarter of 2016, 13.3% of survey respondents on net indicated that overall lending standards on AD&C loan availability had eased. However, the net share of respondents reporting that lending conditions have eased in the second quarter of 2016 is lower than the net share reporting easier standards at the same time in 2015, 30.7%. The index is constructed so that negative numbers indicate credit easing, and positive numbers mean that credit is tightening.

The Federal Reserve Board also tracks lending standards on AD&C lending. In contrast to the NAHB results, the Federal Reserve Board’s Senior Loan Officer Opinion Survey (Fed SLOS) indicates that lending standards continue to tighten. As illustrated by Figure 1 above, lending conditions reported by the Federal Reserve Board began to tighten on net in the second quarter of 2015 and has remained tight in successive quarters.

Given the recent divergence of the two indexes it is important to understand the similarities and differences between them. Although both the NAHB’s Survey on AD&C Financing and the Fed SLOS track AD&C lending conditions, the Fed survey includes commercial real estate lending excluded from the NAHB measure, most importantly nonresidential construction loans. Illuminating the significance of this difference, summary statistics on the outstanding amount of AD&C loans provided by the Federal Deposit Insurance Corporation (FDIC) indicate that home building construction loans are the smaller portion of all AD&C loans on bank balance sheets, as shown in Figure 2 below. The inclusion of nonresidential construction loans in the Fed’s index and their dominant size over residential construction loans is likely an important factor in the recent divergence.

One caveat in this analysis is that the lending standard surveys are focused on the origination of new loans, while the FDIC data captures the yearend stock of loans, reflecting the net flows in (e.g., originations) and flows out of bank loan portfolios over the course of the year. If recent originations, and associated lending standards, in the Fed survey do not reflect the proportions in the current stock of loans, inclusion of the nonresidential construction loans explains less of the divergence.


The role played by regulations imposed by Basel III could be another potential reason for the recent difference in the results of the two surveys. Basel III refers to the significant revisions made to the regulatory capital rules for banking organizations. Basel III introduced the concept of High-Volatility Commercial Real Estate (HVCRE). Under the new rules, HVCRE was broadly defined as all AD&C commercial real estate loans except one-to-four family residential AD&C loans.

Under the Basel III bank regulations, unless certain exceptions are met*, all loans that meet the definition of HVCRE are assigned a risk weighting of 150% for risk-based capital purposes. Prior to January 1, 2015, these loans would have typically been assigned a risk weighting of 100%. Loans for 1-4 family residential construction were not included in this higher risk weight category instead requiring a risk weight of 50% or 100%.

To the extent the higher capital requirements dissuade lenders from making HVCRE loans (and this is reflected in lenders’ responses to the Fed survey), the higher capital requirements could represent an implicit tightening of lending standards, as opposed to an explicit tightening (e.g., higher credit scores, lower LTVs, etc.), and contribute further to the divergence between the two surveys.

Banks, both those with only domestic offices and those with both domestic and foreign offices, report the outstanding amount of HVCRE in their quarterly reports of condition and income, commonly referred to as “call reports”. Using information in the bank-level data provided by the Federal Financial Institutions Examination Council (FFIEC), Figure 3 below shows the distribution by risk weight of the outstanding amount of HVCRE loans, both the amount held for sale and the amount of loans and leases net of unearned income.


Consistent with the intent of the new regulations, the majority of HVCRE loans have a risk weight of 150%. In the first quarter of 2015 89% of the outstanding amount of HVCRE loans had such a risk weight. By the second quarter of 2015 97% of HVCRE loans had a risk weight of 150%. The sharp increase in the proportion of HVCRE loans with a risk-weight of 150% may simply reflect misinterpretation of the definition of HVCRE loans. The FDIC published answers to frequently asked questions dated March 31, 2015. These answers contained specific examples of what loans constituted HVCRE debt and suggest that there was some confusion regarding the HVCRE categorization. Since the second quarter of 2015, the share of HVCRE loans has further concentrated in the 150% risk weight category.

* As discussed by the American Bankers Association, the exclusions to the HVCRE definition are more nuanced. As they explain, in addition to 1-4 family residential AD&C loans another exception includes commercial real estate loans that meet the following 3 criteria.

1.) Meet applicable regulatory LTV requirements

2.) The borrower has contributed cash to the project of at least 15 percent of the real estate’s “appraised as completed” value prior to the advancement of funds by the bank

3.) The borrower contributed capital is contractually required to remain in the project until the credit facility is converted to permanent financing, sold or paid in full.

** The FDIC provides the following definitions for each risk bucket:

0% risk weight –  The portion of any HVCRE exposure that is secured by collateral or has a guarantee that qualifies for the zero percent risk weight. This would include the portion of HVCRE exposures collateralized by deposits at the reporting institution.

20% risk weight – The portion of any HVCRE exposure that is secured by collateral or has a guarantee that qualifies for the 20 percent risk weight. This would include the portion of any HVCRE exposure covered by an FDIC loss-sharing agreement.

50% risk weight – The portion of any HVCRE exposure that is secured by collateral or has a guarantee that qualifies for the 50 percent risk weight.

100% risk weight – The portion of any HVCRE exposure that is secured by collateral or has a guarantee that qualifies for the 100 percent risk weight.

150% risk weight – HVCRE exposures, as defined in §.2 of the regulatory capital rules excluding those portions that are covered by qualifying collateral or eligible guarantees.

Application of Other Risk-Weighting Approaches – Any HVCRE exposure that is secured by qualifying financial collateral that meets the definition of a securitization exposure or is a mutual fund.


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