We produce a report for our board under Part 365 to show which of our loans exceed the supervisory loan-to-value ratio limits, which we call the Loan Value Risk Report. We currently calculate these ratios based on the original purchase price for a property. In many cases, the purchaser constructs improvements on the property (though we don’t call these construction loans), after which we obtain a new appraisal at a higher value. For purposes of calculating the supervisory loan-to-value ratios in these cases, can we use the higher appraised property values after the improvements are completed?

We believe you may calculate the supervisory loan-to-value ratio using the appraised value of the improved property, provided that your bank obtained an updated appraisal after the improvements were completed. The Interagency Guidelines outlining the calculation and reporting of loan-to-value ratios provide that loans should be removed from your Section 365 board reports when the borrower has contributed additional collateral, such as by making “improvements to the real property securing the loan.” Consequently, in such cases, irrespective of whether the borrower used loan proceeds to make the improvements, your bank may use the higher appraised value for purposes of calculating the supervisory loan-to-value ratio. We confirmed this conclusion with an FDIC staff member.

However, in situations where the property has not been improved and the purchase price is deflated (such as when the property is purchased from a family member at an artificially low price), we believe your bank must calculate loan-to-value ratios for purchase loans using the purchase price of the property (or the appraisal value, but only if it is lower than the purchase price). The Interagency Guidelines generally define the property “value” for a purchase loan as “the lesser of the actual acquisition cost or the estimate of value.” We confirmed with the FDIC staff member that you must use the purchase price of the property, and you may not use a higher appraised value for purposes of the Section 365 report (even though using the much lower purchase price is illogical and does not reflect the property value). The FDIC staff member noted that while such loans must remain on your Section 365 board reports, examiners will easily understand that the purchase price does not reflect the property value for these loans.

For resources related to our guidance, please see:

12 CFR Part 365, Subpart A, Appendix A, Interagency Guidelines for Real Estate Lending Policies, Loans in Excess of the Supervisory Loan-to-Value Limits (“The agencies recognize that appropriate loan-to-value limits vary not only among categories of real estate loans but also among individual loans. Therefore, it may be appropriate in individual cases to originate or purchase loans with loan-to-value ratios in excess of the supervisory loan-to-value limits, based on the 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.”)

12 CFR Part 365, Subpart A, Appendix A, Interagency Guidelines for Real Estate Lending Policies, Definitions (“Value means an opinion or estimate, set forth in an appraisal or evaluation, whichever may be appropriate, of the market value of real property, prepared in accordance with the agency’s appraisal regulations and guidance. For loans to purchase an existing property, the term ‘value’ means the lesser of the actual acquisition cost or the estimate of value.”)

12 CFR Part 365, Subpart A, Appendix A, Interagency Guidelines for Real Estate Lending Policies, Supervisory Loan-to-Value Limits (“[A] loan should no longer be reported to the directors as part of 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.”)

12 CFR Part 365, Subpart A, Appendix A, Interagency Guidelines for Real Estate Lending Policies, Supervisory Loan-to-Value Limits (“The supervisory loan-to-value limits should be applied to the underlying property that collateralizes the loan. For loans that fund multiple phases of the same real estate project (e.g., a loan for both land development and construction of an office building), the appropriate loan-to-value limit is the limit applicable to the final phase of the project funded by the loan; however, loan disbursements should not exceed actual development or construction outlays.”)

FDIC Article, Supervisory Insights From the Examiner’s Desk . . . Examiners Report on Commercial Real Estate Underwriting Practices (“Examiners provided examples of institutions failing to monitor the loan portfolio appropriately for loan-to-value exceptions (see text box, Supervisory Loan-to-Value Limits). The following were common deficiencies: . . . Underwriting raw land loans in excess of prescribed loan-to-value limits based on ‘As Complete’ appraised values; . . .”)