Many banks that traditionally lent money to builders now find themselves on a government watch list. The FDIC’s list of problem banks numbers 117, up from 90 the previous quarter. The majority of the new problem institutions have a concentration in construction and development loans, say FDIC officials. Many of them are regional banks, which on a percentage basis have a bigger exposure to real estate. Banks socked by delinquencies must typically hoard money against losses and curtail new lending.
Analysts say that mid-size community banks are the most likely to fail during major economic downturns. Though the scenario hasn’t materialized yet in many places, if it does, these banks will do whatever they can to collect, even call loans that they know will cause builders to fail.
Measuring the Fallout
Some markets have been more hard-hit than others. When the housing industry first began to turn in Atlanta in mid-2006, there were roughly 2,400 builders in the market. By the end of this year, estimated one local banker at a recent investment conference, half of them will be left standing. Already, local powerhouses such as Robert Harris Homes and The Macauley Cos. have gone out.
Phoenix is another market with a high casualty rate. Industry veteran George Casey believes that many of these firms started in the ’90s without a proper understanding of the kind of capital structure they needed. “Home building and land businesses need to be capitalized differently,” says Casey, who works for DMB Associates. “You need a source of long-term debt to operate as a land developer. It’s the poorly capitalized builders that are going out of business.”
Burns believes that overhead expenses will do in a lot of builders. Many public builders are reporting SG&A (selling, general, and administrative expense) running from 15 percent to 20 percent, when 10 percent used to be closer to the norm. Some of the private companies he’s worked with have overhead expenses that are closer to 40 percent. It’s hard to make those numbers work with two sales per month, he says. “That will kill you. It’s overhead that will bring these builders down.”
When Tim Eller, chairman and CEO of Dallas-based Centex, surveys the private builder landscape in the markets in which Centex operates, he sees a lot of carnage and more on the way. “The potential for consolidation is huge,” says Eller, adding that Centex is reconsidering its decision to leave some markets, because very few large competitors are left. “The potential loss of private builders is beyond my wildest imagination.”