Following OCC's presentation, attendees shared interpretations, ideas and practices they use to manage related risks and promote safe and sound operations. Federal banking regulators issue two types of documents; requirements, which all regulated banks are required to comply with; and guidance, which may be implemented in different ways by different lenders.

Globe St.com: Can you explain what these new rules mean for construction lenders?

Tryon: High Volatility Commercial Real Estate (HVCRE) rules fall into the first category. Essentially, HVCRE require lenders to reserve a greater portion of capital against losses from HVCRE loans, including construction loans that don't meet certain criteria. According to participants, increased reserve requirements could result in increased construction lending costs in the range of 40 – 150 basis points. The requirement has not been implemented uniformly by all federal regulators, which is expected to lead to additional clarification in the form of frequently-asked-questions, to be issued jointly by OCC, FDIC and the Federal Reserve Board.

Vendor management guidance falls into the second category, so can be implemented differently by different lenders. There is no one, right way of applying guidance to lending portfolios since the risk appetite, policies, and portfolios vary significantly among lenders. Lenders who classify consultants as high risk vendors may be required to underwrite consultants almost as if they were applying for a loan, but consultants classified as lower risk may be subject to little scrutiny.

GlobeSt.com: What kind of best practices that can help prevent construction loan failures did the group share?

Tryon: At last year's roundtable, the group began working on a framework for a construction document and cost review, frequently used by the industry to evaluate construction loans. The concept of this kind of review has been around for decades, but no industry standards have been developed, and the development of a framework is challenging given the differences in portfolios and risk appetites among lenders. Based on a survey conducted last year, as well as follow up discussions, we talked about a draft framework for pre-construction reviews which identifies fundamental principles and objectives of the assessment, qualifications of providers, and the types of documentation frequently needed, as well as three levels of review to accommodate the lender's needs in different situations. Additional refinements are planned over the coming months.

GlobeSt.com: How does active construction risk management add value for construction lenders?

Tryon: In the last five years over 10% banks reported failure of construction projects. Over 50% of those failures occurred as a result of construction cost overruns. Additional failures occurred because of project delays, contractor or subcontractor failures, and dwindling investment capital. Nearly 80% of respondents reported the use of in-house or third-party professional staff to conduct due diligence on construction projects. Studies and guidance reported by the OCC recognize the value of strong, independent controls in limiting construction-related losses. By itself, this loss avoidance provides significant value to lenders, but strong controls can also allow lenders to comfortably increase the proportion of their loan portfolio that is allocated to profitable construction lending, and to lend on more complex developments, both of which contribute to the bottom-line.

GlobeSt.com: What is your major take away from the roundtable?

Tryon: Every time we have hosted this conference, we are impressed with the expertise and collaboration demonstrated by the participants. By collaborating with their peers, participants help to raise the quality of risk management throughout the industry. Not surprisingly, construction loan failures increased substantially during the downturn. With those losses fresh in mind, lenders and regulators are taking steps to minimize risks going forward; but lenders make money by taking risks, and construction lending can be extremely profitable. Best practices shared at the conference can help all lenders support sound decisions and minimize future problems which can be associated with construction lending.

Bill Tryon is the Executive Director of the Construction Lenders Risk Management Roundtable. Lenders who are interested in participating in the group can reach him at [email protected].