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.”

Learn more about markets featured in this article: Los Angeles, CA.