The unsustainable housing boom of 2003–2005 left behind huge excess supplies of developed land and vacant houses that still are pushing prices downward in many areas of the country. We’ve already faced major tightening of lending standards in home mortgage markets, and that process naturally has made its way to the markets where builders and developers raise funds. In fact, we’re now threatened with a bona fide credit crunch in land acquisition, land development, and construction (AD&C) loan markets.
Recent NAHB surveys of builders and developers document systematic tightening of conditions in residential AD&C markets with respect to both the availability of new loans and the treatment of outstanding loans. In our June survey, none of the respondents said that the availability of new AD&C loans was better in the second quarter of this year than in the first quarter. By contrast, 84 percent said the availability of land development loans had gotten worse and 70 percent said single-family construction loans were harder to get. This round of tightening was on top of earlier rounds documented by the NAHB since mid-2007.
The majority of builders reporting reduced availability of new AD&C loans cited lower allowable loan-to-value or loan-to-cost ratios, and many referred to higher interest rates and loan fees as well as a range of heavier collateral and documentation requirements. Two-fifths also said that lenders now are requiring out-of-pocket payment of accrued interest or borrower funding of interest reserves.
Jumping the Gun
About one-fourth of respondents to our June survey said that their lenders were tightening terms or conditions on outstanding AD&C loans prior to maturity. The tightening generally was implemented by demanding additional assets as collateral, requiring partial pay-down based on reappraisals, refusing to allow additional draws, terminating lender-funded interest reserves or simply calling the loans.
We asked builders and developers about reasons given by lenders for restricting the availability of new AD&C loans or for tightening terms or conditions on outstanding loans. More than half relayed that regulators were forcing lenders to do it, and close to half said lenders’ boards of directors were demanding tighter standards. Other frequent responses were: regulatory or accounting rules, lender concerned about loan performance, and property located in declining market.
The federal financial regulators insist that they are not trying to force depository institutions out of residential AD&C markets. But our surveys of builders and developers show that regulators and lenders, working together, are marching us toward a credit crunch akin to the devastating experience of the early 1990s.
Regulators need to recognize that not all housing markets are in retreat and not all projects in troubled markets spell trouble for lenders. Regulators need to consider collateral damage done to housing markets and the economy by overly stringent application of overly broad messages being sent to regulated lenders across the country.
The Greenspan Fed took the lead on this front in the early 1990s. Hopefully the Bernanke Fed will be the voice of reason in the current episode.