Deconstructing More Bad Loans

Lenders can at least tell themselves that there is a hope of refinancing or selling loans secured by cash-flowing properties – and land is the devil’s plaything. But in-between is another problem sector: construction loans. Who wants a non-performing loan where you have to put in yet more money to build something not worth the cost? Expect to see more stories like the following one.

Small Banks’ Reckoning Day Is Coming
Wall Street Journal – Michael Corkery, Jennifer S. Forsyth and Lingling Wei – 2 July 2008

According to the Federal Deposit Insurance Corp., $45.4 billion of the $631.8 billion in construction loans outstanding at the end of the first quarter were delinquent. When banks announce second-quarter results in coming weeks, they are expected to report sharp increases in loans that builders can’t repay. Banks are also facing intensifying pressure from federal and state regulators to deal with the problem loans on their books…Banks have begun to dump bad construction and land loans at discounts, curtail new lending and halt construction projects that are under way to preserve capital. Some analysts even see a wave of bank failures as a possibility…Nearly one in three of the banks analyzed — or 2,182 — had construction-loan portfolios that exceeded 100% of their total risk-based capital…73 of those banks had construction-loan delinquency rates of more than 25%…Larger regional banks also face mounting construction-loan problems, but are in decent shape. Thirty-eight of them had more than 100% of their total risk-based capital in construction loans at the end of the first quarter, but only nine of those faced delinquency rates of more than 10%…Over the next few quarters, banks are expected to begin recording much larger losses. In 2007 and the first quarter of this year, U.S. banks wrote down just 0.7% of their residential construction and land assets as bad debt…Over the next five years that figure could rise to 10% and 26%, which would amount to about $65 billion to $165 billion…Credit Suisse analyst Dan Oppenheim estimates that as many as 50% of the closely held builders won’t survive because of the tightening lending environment and housing downturn…Large banks, such as IndyMac Bancorp Inc. and KeyBank, have been trying to sell billions of dollars of construction and land loans…Analysts question whether some small banks are putting off foreclosures because they lack adequate capital to absorb the large losses…Banks seeking a quick fix by selling off their troubled loans may find fewer buyers…