The NCUA's Construction and Development Limits

The NCUA has set standard limits on all Construction and Development (C&D) Loans at 15% of capital of a credit union.  The goal of the limits is to help manage the risk of construction lending.  It seems that the regulators attempt to treat all construction with the same level of risk with this broad stoke approach to construction lending.  The question is, “Do all construction loans have the same risk?” 

I will contend the answer is no.  My years of commercial lending have taught me that each construction project has its own unique risk.  It would be impossible to create separate regulations for each loan.  However, there are some characteristics of different types of construction lending that tend to have greater or less risk than the other.  Consider the differences among these various construction projects.

Spec Construction vs. Owner Build:  A project that is built with the intent to sell all or parts of the construction is more risky than a construction project built for the use of the owner or one that has a committed quality tenant who has the capacity to handle fulfillment of the rental agreement.  A subdivision lot development or a large condominium development where the repayment is the successful sale of the lots or units is a higher risk than the construction of a building for the use in the operation of a business.  A manufacturer building a factory, an hotelier constructing a new hotel, or a developer building a retail building that has established credit tenant support will be a lower risk than spec construction of a subdivision.

Credit Union Managed Construction vs. Qualified Third Party Managed:  In many cases, credit unions do not have the staff talent and experience to properly manage larger construction projects.  This poses a higher risk than a construction loan that has disbursements managed with a third party title company or attorney firm.  In general, the construction inspection process is also better with a qualified third party architect or building inspector instead of utilizing the field lender.

Construction without Permanent Financing vs. End Loans in Place: Here any construction project that has permanent financing in place at the onset of the construction is less risky than a construction loan with no end loan in place. 

Repayment from the Sale of the Development vs. Debt Servicing from Other Sources:  If the repayment of the principal of the construction loan is based upon the sale of the development or building, it is considered speculative.  This is a higher risk than construction that will eventually have the principal serviced with non-speculative sources.  These could include regular P&I payments that are supported by a lease on the property or an owner use property where the amortized payments are supported by the positive net operating income of the business. 

The spirit of the NCUA limits is to help manage the risk of construction projects.  However, as shown above, some projects pose more of a risk than others and should be subject to appropriate limits.  Using the low limits may be appropriate in limiting construction that is spec, credit union managed, and has no end loan in place.  The current low limit is not applicable for owner or tenant built, qualified third party managed, and projects that have a final loan in place that is supported from historical net operating income.  I would contend that construction loans with the latter characteristics should not be subject to the 15% limit.  Such limits hinder credit unions from supporting its membership base with lower risk construction loans, which in turn, hinders economic growth in the market area.  It also causes credit unions to turn down lower-risked construction loans that will turn into good earning assets to help the credit union’s earnings and equity grow.  But whether or not the NCUA agrees with me, it is still the lender’s responsibility to recognize the variations of construction risk and act appropriately.