Borrower applies to purchase commercial property to be used as residential. Lender researches and finds out that property could be zoned residential if parking lot is removed. Tells borrower verbally that we can provide temporary financing to remove parking lot or commercial financing. Borrower says that another bank has agreed to give them conventional financing. Borrower classifies loan as withdrawn for HMDA purposes. I think this should be classified as denied. Thoughts?

I agree with you, it's a denial. The bank denied the loan as the applicant requested.

If you made a credit decision, you can't use withdrawn...It would be approved not accepted.
If you made a counter-offer and they declined to take the counter, you would deny the application.