Construction Loans Get Worse

From the NYT:

Even as the economy may be starting to recover, banks across the country are confronting a worsening outlook for their construction loans, an area that boomed for much of the decade.

Reports filed by banks with the Federal Deposit Insurance Corporation indicate that at the end of June about one-sixth of all construction loans were in trouble. With more than half a trillion dollars in such loans outstanding, that represents a source of major losses for banks.

Construction loans were highly attractive in recent years for many banks, particularly smaller ones without a national presence. One reason was that other types of loans were not easy to make. A handful of big banks came to dominate credit card loans, for example, and corporate loans were often turned into securities.

Construction loans, however, needed local expertise and were not easy to standardize. In a booming real estate market, there were few losses on such loans.

The problems now extend well beyond loans for the construction of single-family homes, where banks have been taking losses and cutting back their commitments for a couple of years. At the end of June, $173 billion in construction loans related to single-family homes was outstanding, barely more than half the peak level reached in the fall of 2006, when the housing market was booming.

It is in commercial real estate construction — be it stores or office buildings — that the pain seems likely to rise. At the end of June, $291 billion in such loans was outstanding, down only a few billion from the peak reached earlier this year.

“On the commercial side,” said Matthew Anderson, a partner in Foresight Analytics, a research firm based in Oakland, Calif., “I think we are fairly early in the down cycle.”

Foresight estimates that 10.4 percent of commercial construction loans are troubled, but expects that to increase as the year goes on.

The definition of troubled loans used in the accompanying charts includes loans that are at least 30 days past due, as well as those on which the bank identified problems that led it to stop assuming that interest on the loans would be paid.

It is possible that some of the rapid rise in problem loans represents pressure from regulators to admit problems, rather than new problems. The number of newly delinquent loans seems to have declined in the second quarter, although it is hard to know if that is a trend that can continue. But the number of loans that the banks do not expect will be fully repaid has soared.

The reports that banks file with the F.D.I.C. do not include details on all types of construction loans, nor on where the construction is. That information is estimated by Foresight, based in part on where each bank operates and on disclosures in other company reports.

Foresight estimates the biggest problems are in loans for condominium construction, with 38% of all construction loans troubled. Mr. Anderson says even that might be an understatement. He pointed to Corus Bank, a Chicago institution that specialized in condo loans. Its latest report shows that its capital is gone and that it expects losses on two-thirds of its construction loans.

Foresight’s estimates of the proportion of problem construction loans in the 20 largest metropolitan areas has one surprise: the one with the largest proportion of troubled loans is Seattle, where the recession has started to pinch. But it is also notable that just one of the 20 areas has less than 10% of construction loans in trouble. A year earlier, most of them were below that level.