Untangling business partner-ships with banks is a messy, expensive, and painful process, as Thomas Dobron, CEO of Innovative Communities, knows all too well.
Dobron liquidated his first home building company, Sunland Communities, in the wake of the 1990s California real estate bust and is now preparing himself to shut down Escondido, Calif.–based Innovative Communities.
“The future for Innovative Communities is very bleak,” Dobron says. “It won’t even go to Chapter 11; it’ll probably go straight to Chapter 7, to liquidation.”
Once a diversified builder and land developer doing business in California, Arizona, and Nevada, Innovative recently laid off all but one member of its staff of 86 employees and is currently just treading water. The company is no longer building in any of its 15 projects, leaving neighborhoods half-built after banks shut off its access to credit.
Dobron would like to come back with a new home building company during a future housing rebound, as he did after Sunland failed in the 1990s, but times have changed, he says. Whereas banks were still lending money in the early ’90s, they either don’t want to or can’t make new construction loans in the face of the current economic crisis.
In dire straits themselves, some banks are forcing builders into bankruptcy and taking possession of the companies’ assets in order to protect the banks’ investments and their own solvency. If a company’s principals signed personal guarantees, the banks can go, and in some cases are going, after builders’ assets and properties.
“I love the concept of the American Dream,” says Dobron, who started working for builders after graduating from college more than 30 years ago. “But today, the American Dream has turned into the American Nightmare.”
During housing downturns, the home building industry tends to lose about 20 percent of its membership. But this recession is far worse, causing some analysts to project that 50 percent or more of home builders could either sell their assets and close their doors or file for bankruptcy.
“There will be many more than in any previous downturn,” says Tony Avila, senior adviser to Americrest Homes of Boca Raton, Fla., a new home building company with private equity backing. “My guess is half of the Builder 100 will go bankrupt, be merged away, or shut down.”
Banks remain under pressure despite the U.S. Treasury’s $700 billion bailout of financial institutions, because so many of the loans they made in the past few years, both to home buyers and to builders and developers, are now worth far more than the assets they back. Banks also bought mortgage-backed securities, assets that have been and continue to be devalued.
Banks are required to maintain certain levels of capital to back the loans they’ve made. With their loans underwater, their capital ratio requirements are going to fall below levels required by the FDIC, which could shut them down.
Housing analysts estimate that many of the 8,500 banks in the U.S. would be insolvent if forced to mark their assets down to current market values.
“There’s a big percent, 10 percent to 15 percent, that would be insolvent,” says Ivy Zelman, CEO of Zelman & Associates research firm in Cleveland.
The state of the economy has everyone, but banks in particular, scrambling for cash. With land values declining so rapidly, banks would rather not take back those assets, but will if a builder stops paying on them. Even a devalued asset is better than nothing.
“They prefer not to take the collateral in almost all cases,” Zelman says. “Where they are taking it, they think it’s hopeless at this point.” But, Zelman continues, “if they think the builder can finish out the project and that would mitigate their loss, they’re willing to do that.”
Banks would rather have cash, says Jim Weigel, a former bank loan officer and now a building products executive and bank work-out specialist and senior consultant with Shinn Consulting of Littleton, Colo.
“Those builders who were successful, who built a good pile of cash and other net worth, there’s a good chance that if the banks can go after it, that’s where they will go first,” Weigel says.
While private equity may be builders’ main source of financing for the foreseeable future, it, too, has its problems.
As land and home prices plummeted in 2007, Dobron lined up a well-heeled private equity partner to help buy Innovative’s debt and land from its banks. Then, the deal fell apart when the prospective partner went belly-up, leading to the near-certain demise of Innovative.
“Who would’ve ever thought that Lehman Brothers would not be around today, for crying out loud?” Dobron says. “It is unbelievable.”
Learn more about markets featured in this article: Los Angeles, CA.
