Credit Likely to Remain Tight For Builders

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.