The New York Times reports tonight on how banks are clamping down on credit to small homebuilders, with the result that many will go out of business.
There were several things I found surprising about the piece:
1. That banks are getting stringent now. The housing market has been on a rapid decline since the summer of ’07 (and showing signs of weakness in the superheated markets earlier) and only NOW are banks tightening credit to home builders in a serious way? This is like closing the barn door after the horse is in the next county.
2. Banks are being indiscriminate. Builder = bad. Although banks routinely make knee-jerk cuts in credit crunches, I am always surprised to see it in operation. Suddenly calling in a credit line would fell most business borrowers. Some of the losses incurred will be self-inflicted. And even for borrowers that were over extended, an orderly wind down (seeing if they had any viable subdivsions near completion and letting them finish them) would often have produced a better outcome.
From the Times:
Dave Brown, one of this [Tempe, Az] city’s best-known home builders, had kept his head above water through the housing downturn, not missing a single interest payment on his loans.
Though Dave Brown’s home-building firm had not missed a payment during the housing downturn, one of his banks suddenly demanded millions of dollars in additional collateral.
So he was confounded a few months back when one of his banks, spooked by the decline in his company’s revenue, suddenly demanded millions of dollars in additional collateral to continue carrying loans on his projects.
He was unable to come up with the money, and in October, JPMorgan Chase foreclosed on five of his developments. Shortly thereafter, Brown Family Communities, 33 years in the business, decided to shut its doors….
“The reality is, we’re seeing conditions in home construction and home finance that are the worst since the Depression,” said Steve Fritts, associate director of risk management policy at the Federal Deposit Insurance Corporation, the government agency that insures bank deposits…
No hard count exists of precisely how many builders have gone out of business since the downturn began. According to an estimate by the National Association of Home Builders, at least 20,000 builders — about a fifth of the total nationwide — have closed up shop in the last two years….
With the industry still owing hundreds of billions of dollars in loans made at the market peak, many more face insolvency in the coming months and years. “Probably north of 50 percent will fail,” Ms. Zelman said.
Much of that borrowed money went to finance land deals that now appear to have been catastrophic miscalculations. In cities like Phoenix, where housing starts are near record lows, demand for undeveloped land has plummeted, and prices have followed…
Yves here. If the banks were funding land speculation, they deserve to have their heads handed to them. Back to the article:
Even builders who are up to date on their interest payments or still managing to sell houses are getting trampled, as in the case of Mr. Brown.
“They’re not distinguishing the track records of one borrower against another,” said John Fioramonti, a real estate consultant in Scottsdale, Ariz. “If you’re a builder, you are a bad risk.”…
More than 15 percent of loans for single-family home construction were in some form of default by September 2008, up from 10 percent in January of that year, according to figures from Foresight Analytics, a housing analysis firm. Still, until recently, banks had largely chosen to keep past-due borrowers afloat, in the hope that a housing recovery might pave the way for them to repay their debts in full.
Only now, with the economic outlook darkening, are lenders stepping up foreclosures of troubled loans. Zelman & Associates, a housing analysis firm, estimates that losses on land and construction loans could eventually reach $165 billion, one reason federal regulators are pushing banks to come to grips with the problem.
“When we talk to regulators now, they say they’ve lost patience,” said Ms. Zelman, who is chief executive of Zelman & Associates.
In this climate, keeping loan payments up to date — something many builders are struggling mightily to do — is not necessarily any protection.
Many loans in the building industry are of short duration, coming up for renewal at least once a year. This allows banks to take a fresh look at the financial health of a borrower, as well as the assets securing their debt. A steep fall in cash flow or a decline in the value of the collateral — usually building lots or half-built houses — can mean an automatic default, whether a borrower has missed payments or not.