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Wednesday, March 11, 2009

Bank Failures and C&D Loans

by Calculated Risk on 3/11/2009 12:45:00 PM

From James Saft at Reuters: Builder loans are the forgotten land mine in U.S. credit crisis (ht Michael)

Banks in the United States face a new source of write-downs and failures in the coming year, as loans made to developers to finance residential and commercial property development rapidly go bad.
Called acquisition, construction and development, or ADC, loans, they total 8.4 percent of all bank loans, just below a 30-year peak, and are used by developers to buy land, put in infrastructure and construct housing or commercial space.

[CR Note: or just C&D loans for Construction & Development]

"Everyone in the media is focused on consumer foreclosures," said Ivy Zelman, a housing analyst at Zelman & Associates. "What they're not focused on is the builder-developer foreclosures, which are only in the early innings and which will continue to wreak havoc as these assets are liquidated at depressed prices. Until they are cleared, there can't be a stabilization in home prices."

Zelman thinks the pressure will cause "hundreds of banks" to close.
Of particular concern is that ADC loans are concentrated in smaller banks, which tend to have deep ties to local developers. ADC loans account for 47 percent of nonperforming loans at small banks, compared with 14 percent at larger banks.
This really isn't a new topic - the FDIC issued a report on emerging risks in 2006 that clearly showed that medium sized institutions ($1-$10 billion in assets) had excessive exposure to C&D loans. And it is really the mid-sized institutions, not the smaller institutions (although plenty of those will fail too because of bad C&D loans).

Here are three key graphs concerning C&D loans based on the FDIC Q4 Quarterly Banking Profile:

FDIC, Excessive C&D Concentration Click on graph for larger image in new window.

The first graph shows the number of FDIC insured institutions with construction loans exceeding total capital.

Not all of these institutions will fail, and not all failures will be because of C&D loans, but this gives an idea of the number of institutions with excessive exposure to C&D loans.

FDIC, C&D Concentration by Asset Size The second graph shows the concentration of C&D loans by institution asset size.

This suggests that a higher percentage of mid-sized banks ($1 to $10 billion range) will fail from C&D losses. There were two examples this year: County Bank, Merced, California had $1.7 billion in assets. Alliance Bank, Culver City, CA had $1.14 billion in assets. Both were seized by the FDIC on February 6th.

Of course there are many more small banks. The FDIC Q4 report shows 7,629 institutions under $1 billion in assets, 562 mid-sized institutions, and only 114 with greater than $10 billion in assets. So most of the failures will be smaller banks.

FDIC, C&D Concentration Noncurrent Rate The third graph shows the noncurrent rate for C&D loans. The rate is rising quickly - hitting 8.5% in Q4 - although the rate is still below the level of the early '90s (related to overbuilding of CRE and the S&L crisis).

Put together, these graphs suggest many more bank failures as the C&D noncurrent rate continues to rise. Other banks will fail because of bad residential loans (like IndyMac), and some institutions from bad CRE loans, but most bank failures will probably be C&D related.