A week ago, The Estridge Group didn’t look like it was long for this world. The Carmel, Ind.–based builder had stopped taking orders and its CEO, Paul Estridge Jr., told 30 buyers he couldn’t build their houses because his company couldn’t obtain construction financing. Estridge was scrambling to raise $2 million to keep open lines of credit with banks that were demanding, in essence, a higher “downpayment” for their loans.
But as has been the case with other builders in similar straits, private equity appears ready to come to The Estridge Group’s rescue. In an interview with Builder on Monday night, Estridge said that since his company went public about its difficulties, he had received 11 contacts from capital sources offering assistance.
Accepting private equity financing would mean that Estridge would give up more ownership of his family’s business, which is already 35% owned by subcontractors that last June invested money into the builder to help it stay afloat. But a new equity infusion, says Estridge, would allow his company to continue operating.
Estridge contends that federal regulators are preventing banks from executing real-estate loans. This has been a common refrain among struggling builders for at least the past two years: Banks won’t lend so as to avoid punitive actions by regulators.
For example, regulators require banks making acquisition, development, and construction (AD&C) loans to builders or developers to increase their loan loss reserves substantially to cover the potential failure of the project being financed. With many banks already working on tight ratios, being forced to move more deposits into this reserve fund would make the loan unprofitable or could even put the bank out of business. Consequently, many banks are refusing to make these loans.
“Banks are scared to death” about being dressed down by regulators, says John Floyd, owner and president of Ole South Properties, a builder based in Murfreesboro, Tenn. Floyd sits on the board of MidSouth Bank and formerly served on the community board of SunTrust Bank, so he’s seen first hand how regulators have kept a tight rein on institutional lenders.
Floyd says regulators continue to push hard for banks to clean up their real estate portfolios “and get them off of their books.” One of the sticks the regulators have been using is the requirement that projects or land being financed get reappraised as often as every six months.
The appraisal process continues to be a hotly debated and controversial topic within the housing industry. The ever-shifting standards that appraisers seem to be following, says Estridge, perpetuate a “self-fulfilling prophesy” where banks won’t lend money to projects that become “toxic” because they couldn’t get financing.
He points to one of his company’s projects, for which one bank lent $7 million. That same bank foreclosed on another project, across the street from Estridge’s, after an appraisal that regulators demanded came in low and the developer couldn’t come up with $1.2 million to rebalance its loan-to-value ratio. The bank sold that land to a public builder for 35 cents on the dollar, says Estridge. “So that builder now has $35,000 lots, where mine are $70,000. How am I supposed to compete with that?”
Estridge’s opinion of lenders was further lowered after being sued by Bank of Indiana last September for failure to repay a $1 million investment in corporate bonds that the builder had sold. Estridge explains that he had the money and was ready to pay the bank until another lender “put a gun to my head” and threatened to pull a $17 million construction loan if he settled Bank of Indiana’s unsecured claim.
Will banks come back to housing?
Federal regulators continue to insist that there’s no policy they are enforcing that prohibits banks from making loans to builders and developers. However, regulators also are quite clear that they are not going to allow banks to engage in the kinds of risky lending that brought the nation’s banking system to the brink.
“There are still a number of banks that are not on solid financing footing,” says William Ruberry, a spokesman for the Office of Thrift Supervision (OTC) in Washington D.C. “Our job is to make sure the banking system is operating safely and soundly.” He notes that every bank is now subject to a CAMELs rating, which is an acronym for capital adequacy, asset quality, management, earnings, and liquidity. Each of these factors is rated on a scale of 1 to 5, and Ruberry says the level of risk a bank is allowed to take can depend on its relative rating.
Ruberry acknowledges, though, that OTS has heard from Congress and elsewhere that “the pendulum may have swung too far,” and that regulators might have made banks overly cautious in their lending practices.
Sheila Bair, chairman of the Federal Deposit Insurance Corp. (FDIC), made similar concessions in a speech she delivered last week at the Independent Community Bankers of America’s national convention in San Diego. She defended her agency’s regulatory enforcement as a reasonable response to the inordinate number of smaller banks that failed because of their high levels of commercial real estate, “especially construction and development concentrations.” But Bair acknowledged as well that there are “thousands” of community banks that have “successfully managed those portfolios. We need to learn from the success stories and promote broader adoption of proven risk-management tools for banks concentrated in CRE.”
Just don’t expect regulators to ease off of the brakes anytime soon, says Paul Nash, FDIC’s deputy to the chairman for external affairs. While there’s been “incremental improvement” in banks’ financial conditions—“we are absolutely coming out of the woods,” Nash states—he’s still “astounded” at some of the problem banks that have crossed his desk lately. These include an Arkansas bank that was financing the construction of a subdivision in Salt Lake City, and a Georgia bank that was building a Hilton hotel in Syracuse, N.Y. “We’ve been urging banks to lend in your markets and know your customers.”
Nash suggests “it’s entirely plausible” that banks are using regulators as “convenient scapegoats” to explain to builders why they can’t lend on projects these banks aren’t enthusiastic about to begin with. “We’re happy to fulfill that role,” says Nash, because FDIC wants banks to make loans they are comfortable with.
Nash expects banks will eventually become important sources of capital again for the housing sector. And Floyd of Old South Properties says he’s noticed that banks have become a bit more receptive to builders’ loan requests in the past six months. Estridge, though, isn’t so sure. He calls what’s been going on “the single most severe thing I’ve seen in the housing industry” in his career, and notes that one lender, Royal Bank of Canada, has completely exited the real estate arena in the U.S. “The banks want out of this space,” he observes.
John Caulfield is senior editor for Builder magazine.
Learn more about markets featured in this article: Salt Lake City, UT.