While their salespeople happily serve this spring’s surge of first-time buyers, builders are looking at their shrinking inventories and wondering where they will get the money to replenish their development pipeline. “Acquisition financing is nonexistent, and the same is true of development financing,” says Robert Mazmanian, a partner with Wathen-Castanos-Mazmanian in Fresno, Calif. “Things from our perspective in California are not easing up” with lenders.
He’s hardly alone in that situation. Builders immediately saw banks tighten up credit last fall, when the financial crisis began, and the government’s billion-dollar bailout to the banking industry seems to have had little effect. Builders can’t get money to buy land. They can’t get loans to develop lots. They can’t convince banks to joint-venture with them on partially finished developments, even when the bank already owns the land and would have minimal risk.
“A lot of builders have been frozen from doing anything,” says Bill Luther, president of Gemcraft Homes in Forest Hill, Md., who has his doubts about the financial industry’s 180-degree attitude change on real estate investments. “Lenders are just causing more problems for themselves.”
The NAHB seems to agree. This spring, it urged regulators and lenders to “work with residential construction borrowers who have loans in good standing by providing flexibility on re-appraisals, loan modifications, and perhaps forbearance, to give builders sufficient time to complete projects and sell their inventory. By not extending loans, banks are depriving builders of the opportunity to find buyers as the housing market enters its peak selling season.” (It also plans to hold a June 25 Webinar on the topic and is collecting information for case studies.)
Unfortunately for builders, the current tight credit situation is likely to continue into 2010, according to experts interviewed by BUILDER in recent weeks. The reasons are myriad: a struggling economy, capital pressures, consumer credit problems, banking consolidation, and regulatory and accounting uncertainties, and of course, falling home prices.
“Do you want to fund land development when you don’t know where the bottom is?” asks Christopher Whalen, managing director for Institutional Risk Analytics, a banking and lending analysis firm based in Torrance, Calif. The answer for many banks obviously is no.
Real Estate Becomes Too Risky
The same recession that has hammered housing has also laid the banking industry low. Net income for FDIC-insured institutions plummeted more than 60% in the first quarter of 2009 compared to the same time a year ago. A major reason: bad loans. According to the FDIC’s most recent quarterly banking profile, FDIC-insured banks and thrifts wrote off nearly $38 billion in loans in the first quarter, which is almost double what it wrote off for the same quarter last year.
Unfortunately for builders seeking capital, real estate loans represent a major factor in those losses.
Last year, banks reported net charge-off rates of 0.99% for all loans and 0.73% for real estate loans for the first quarter. This year, those figures doubled, to a net charge-off of 1.94% for all loans and 1.44% for real estate loans.
A similar trend occurred in noncurrent loans, which are at least 90 days past due. Overall, banks said 3.77% of all loans were noncurrent in the first quarter of this year, compared to 1.72% one year ago. A prime offender? Real estate, where the percentage of noncurrent loans jumped from 2.21% in 2008’s first quarter to 4.89% for 2009’s first quarter. Within that category, construction and development lending is the most troubled, with nearly 11% of such loans more than 90 days past due.
Even worse from the banks’ perspective, the bulk (61%) of the industry’s current $7.7 trillion in loans outstanding is in real estate loans, including $567 billion in construction and development lending. “Even in situations where builders are still doing business, banks don’t like the credit risk,” Whalen says. “Why would they?”
The banking industry’s abrupt aversion to real estate risk has resulted in serious financial challenges for builders, who have had their loans called and their credit lines yanked—often with little warning. “It’s easier for them to pull a line before it becomes a problem than to work it out once it becomes a problem,” says Gary Deutsch, a certified public accountant who has more than 40 years of banking industry experience and the current president of BRT Publications in Berlin, Md.
Even private equity is pulling back. “Capital that will be available in the near term is going to be expensive,” says Andrew Hede, a managing partner with Alvarez & Marsal in New York. “Capital is also going to be very cautious about people getting into large land buys.”
Banking Consolidation Causes Challenges
Builders large and small are well acquainted with the influences of consolidation in the housing industry, where public builders and large private firms have garnered a significant share of the new-home market. But in this recession, it is consolidation in the banking industry that is truly impacting home builders. Just look at a few of the recent major transactions: J.P. Morgan Chase’s purchase of Washington Mutual, Wells Fargo’s merger with Wachovia, Capital One’s acquisition of Chevy Chase Bank.
Such mergers and acquisitions affect builders in multiple ways. First, banking consolidation may reduce their total number of lending partners. Second, they may lose the local contact who knows their company and their projects. And third, the level at which lending decisions are made could change dramatically at a new bank.
“Community financial institutions are relationship-oriented institutions,” Deutsch says. “Bank executives are often working directly with the [business] owner. They’ll take action to work with a borrower through a troubled loan and may be more willing or able to make modifications to a loan or their policy and procedures. At regional banks, that begins to change.”
At a regional institution, committees often evaluate loan applications, typically with less flexibility than a local bank might, according to Deutsch. The process becomes even more straightforward at big, national banks, where centrally located decision-makers choose who—and who doesn’t—get a loan. “The potential for flexibility is there, but typically the decision is just more businesslike,” he says.
It has created a difficult dynamic for builders, especially for those trying to refinance a struggling development funded by multiple banks. The refusal of just one lender to approve a restructuring could result in a builder going into foreclosure or worse. Such arrangements are “not as clear as with a syndicate, where there is clearly a lead bank,” Deutsch says. “With participation, it’s like a partnership—you have to convince everybody.”
That’s not always possible, as the bankruptcy of Village Homes of Colorado showed.
“It’s become a full-time job for builders—working with banks and trying to squeeze out enough money to survive,” observes Luther of Gemcraft Homes. But such duties can’t be neglected. “If you don’t have really great relationships with banks, you’re not going to get any money.”
Land Exerts Influence Good and Bad
But it’s the issue of land that is really complicating matters.
Many banks, already weighed down by significant numbers of real estate owned (REO) properties, are wary of adding any additional land investments to their books, even in relatively low-risk joint ventures where the bank supplies the REO land and builders simply construct the homes.
Just like builders and homeowners, falling land values have eroded the value of banks’ land assets, forcing them to raise capital to protect against potential losses. In this declining market, they must also boost their reserves enough to satisfy bank examiners, who expressed worries about commercial real estate lending exposure at banks as early as 2006. Banks “want to get back into the business of lending as soon as possible,” Deutsch believes, “but they’re worried about regulators, and regulators are still concerned about commercial real estate lending concentrations.”
Accounting rules add another wrinkle. For accounting and financial risk reasons, regulators may not approve of a bank’s continued involvement in a real estate project and want the lender to realize any gains or losses as soon as possible. As a result, banks are doing everything they can to exit land deals quickly because if the project drags on (which is certainly likely in today’s weak market and struggling economy), bankers may need to account for that dirt differently due to its “troubled status,” Deutsch says. “And once a project goes into troubled status, the objective is generally to sell it within a year so it is no longer carried on the books.”
This lender reluctance to hold land has benefited builders who have maintained their access to capital.
Wathen-Castanos-Mazmanian, for example, was able to obtain a development loan on a California project because the bank had already funded the land deal. “It just shifted the financing from the land [acquisition] to the [land] development,” Mazmanian says. “They wanted us to build, and this was an incentive [for the banks] to get out of the land debt.”
Similarly, Ole South Properties CEO John Floyd says banks have been willing to lend his Murfreesboro, Tenn.-based company construction funds because they’ve already lent the builder the money for the land. “If I don’t use that land, there’s no one else to buy it, so the banks want us to build out what we own as fast as we can,” says Floyd, who doubts he could get new AD&C money today.
Lack of resources may be another issue, particularly at smaller banks. At the same time as builders are begging and pleading for funding, lending institutions are dealing with a host of other challenges requiring time and resources—new credit card laws, personal and corporate bankruptcies, foreclosures, and mortgage modifications. They simply may not have the people, time, or expertise to carefully evaluate a builder’s proposal, no matter how promising.
“It’s not an easy decision, but builders don’t know that,” Deutsch says. “They don’t see what’s happening behind the scenes.”
Alison Rice is senior editor, online, at BUILDER magazine. Senior Editor John Caulfield also contributed reporting to this story.
For practical advice on how to protect your company from a credit crisis, click here.