Construction Developer Says Banks Suddenly Playing Hardball, Asks "Mish, What's Going On?"

Today I received an email from "Construction Insider" concerned about banks suddenly playing hardball and calling in construction loans.

Construction Insider writes:

Hi Mish

I work in the construction business and something has been creeping to the forefront of my attention for the past few weeks and now it seems to be moving full steam ahead.

Banks are forcing developers/builders (especially smaller ones) to give up their properties (unsold homes and lots).

Banks say the reason is that the properties in question are no longer performing assets. I am sure there are some loans out there that are not performing and the owners are going under. I am equally sure that there are plenty of developers that are still selling homes - just not at the pace originally planned on the pro formas.

Having inside information on one of these scenarios that happened today, I cannot help but wonder what is really going on? The bank told a small developer/builder I work for that they were taking back his ongoing subdivision.

He is selling houses and updated pro formas would indicate that the current sales pace would exhaust all remaining lots within 33 months. Yet the bank stated they would only give him until April 15 to find alternative financing. The bank is also willing to let him buy the subdivision at a 33% discount to what is currently owed.

If he is unable to obtain this backing, the bank will let him walk away without penalty or consequence so they can write it off.

I have been on the phone trying to put some of these pieces together. It seems there are many banks doing the same thing. However, there is apparently no interest [or ability - Mish] from anyone wanting to pick up land/lots at 30% - 50% discounts to today's prices.

Another interesting point is that the banks all state that they must have these situations written off or taken care of by the end of Q2.

These are the immediate questions running through my head:

Why the end of Q2? And why do so many banks seem to be simultaneously doing this?

Is it possible that there is some government incentive to the banks to meet this timeline? And how much will this cost the taxpayers?

There is something extremely concerning about this whole thing, especially from the standpoint that many banks appear to be acting in concert, all with the same specific timeline. Any thoughts you have would be greatly appreciated.

Construction Insider

For questions like these, I turn to my "California Business Banker" to see what he thinks.

"California Business Banker" responds:

Hi Mish

Your construction industry source raises an interesting issue. Since I work for a relative healthy bank, I don't see that in my bank.

However, we have had federal auditors in the bank for the past couple weeks and I've noticed an interesting development. They are getting tougher on banks recognizing loans that they view as a problem and pushing for downgrades.

So, the very problem might be federal auditors are forcing banks to down grade loans to a doubtful status. In such cases as nonperforming real estate assets, this essentially forces the bank to do something more than wait and see if the developer can turn his investment and pay off the bank.

It forces banks to resolve the issue mostly by enforcing their rights on the collateral, which is why they are probably recommending the developer walk away, so they can their hands on the collateral sooner (maybe deeding it over to the bank) versus going through foreclosure and potential bankruptcy on behalf of the client, which can draw out the process for months.

Most banks would like to get in, fire sell it or sell the note, and move on and not expand the loss by waiting over time.

It wouldn't surprise me a bit, if conceptually this or something very close to this is what's going on.

The auditors reviewing one of my loans want to down grade the loan simply because the owners personal credit score has declined. Bear in mind the client is profitable and meets all of their financial covenants.

Personal credit is a red flag but usually not a reason to down grade loans, unless there are other reasons as well. This tells me the federal auditors are getting tougher across the board.

Hope that sheds some light.

California Business Banker.

Signs Say Wave of FDIC Takeovers Coming in 3rd Quarter

Thanks "Construction Insider" and "California Business Banker".

Putting 1 and 1 together, I sense the FDIC has decided to take problem loans by the horns, forcing banks to address those problems. Banks with enough capital to take huge writedowns will survive, those that don't, won't. Many won't.

If the above scenario applies to commercial real estate as well as housing, expect a huge wave of FDIC bank takeovers in the third and fourth quarters, spilling over into next year. In the meantime, expect to see more lending contractions as banks fearful of this regulatory crackdown respond with further cutbacks in business lending, especially small business lending.

Addendum:

"Rebel Farmer" writes:

A friend of mine is a loan officer at a small regional bank here in Oregon. She told me last week that she cannot get any of her mortgage loans clients approved for loans because the bank has raised the qualifications so high that NO ONE is being approved for home loans. These are all borrowers who are more than qualified. If she does not make her quota this month for closed loans, per her boss, she will be getting her pink slip on March 31.

There is definitely something going on at banks for all types of loans. They are hunkering down. My banker friend believes also that there is going to be a massive failure of many banks in the near future.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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