Construction Debt Casts Long Shadow Over Banks' CRE Portfolio

CRE Finance World, Winter 2013

Construction Debt Casts Long Shadow Over Banks’ CRE Portfolios Jack Mullen Founder and Managing Director Summer Street Advisors, LLC A real estate (CRE) asset quality indicators continued to for mid-size and large banks, running 9.6% for community banks.Construction Loans Produce Shaky FoundationAcross the board, the delinquency rate at the end of June washighest for construction loans. Noncurrent C&D loans exceeded 11%s 2012 comes to a close, the complexity of America’s realestate crash in the banking sector continues to unfold.Looking at the big picture, FDIC data for the nation’s 7,246banks and federally chartered thrifts showed commercial improve in the first half of 2012. One important milestone was Chart 2 reached as total delinquent CRE loans and foreclosed properties U.S. Banks % Noncurrent CRE Loans by Asset Size fell below $100 billion, down almost 28% from a year ago. Despite slow but positive progress, closer scrutiny on underlying asset classes in banks’ loan portfolios reveals the rocky road to recovery continues, particularly for smaller banks. The nation’s community banks, defined as having assets less than $1 billion, and mid-sized banks with assets of $1-$10 billion, continue to be vulnerable to disproportionate CRE exposure. While CRE loans comprise 14% of the $700 billion in banks’ aggregate portfolios, mid-sized banks have 29% and community banks 30% exposure, compared to 9% for banks with assets over $10 billion. Even more challenging for the sector is the concentration of construction and development (C&D) loans: $51.9 billion (6%) at mid-sized banks and another $55.1 billion (6%) at community banks. At mid-year, the combined $107 billion in C&D loans is Mid-year REO statistics also tell a sobering story. The FDIC almost equal to the $110.3 billion (2%) on the books of large reported a total $41.8 billion in REO at the end of June, of which banks with assets over $10 billion. $14.3 billion (34.2%) falls in the C&D category. Community and mid-sized banks hold the lion’s share, $5.8 billion and $4.7 billion, Chart 1 respectively, $10.5 billion combined – 74% of all construction and U.S. Banks Loan Portfolio by Asset Size development REO. Acquisition, construction and development loans (ADC) can be relatively high-risk, even in a boom economy. Many of the 407 banks that failed since 2007, and those that remain in serious trouble today, did not fully appreciate the concentration risk of construction and land development exposures in a down market. Portfolios of small and regional banks are more heavily weighted to secondary and tertiary markets, where pricing has been slow to recover. Refinancing in these markets remains difficult, even for properties with stable cash flow. Even before the sector crash, mid-sized banks had significantly higher concentrations of ADC loans than community banks and large banks. At the end of June 2012, mid-sized banks still held almost 40% of risk-based capital in construction and development loans, more than double the exposure of small and large lenders. This situation highlights the severe risk of CRE losses that many banks still face. CRE Finance World Winter 2013 52


CRE Finance World, Winter 2013
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