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Small Banks Getting Battered By Construction Loans

Back on March 25, I mentioned that the Associated Press was reporting the Federal Deposit Insurance Corp., or FDIC, was planning to increase staffing 60% to handle an anticipated surge in troubled financial institutions. From that post:

The Federal Deposit Insurance Corp. wants to add 140 workers to bring staff levels to 360 workers in the division that handles bank failures, John Bovenzi, the agency’s chief operating officer, said Tuesday.

“We want to make sure that we’re prepared,” Bovenzi said…

Now, I can see why. The Wall Street Journal said last week:

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.

That will put additional pressure on an already stressed financial system. 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.

Delinquency Rates from Construction Loans
Source: Wall Street Journal

According to Journal reporters Michael Corkery, Jennifer S. Forsyth, and Lingling Wei, problems were brewing among small banks earlier this year. They wrote:

Scores of banks were already suffering headaches by the end of the first quarter, according to a review by The Wall Street Journal of FDIC-filed reports by 6,919 banks that make construction loans. The smallest banks, those with total assets of less than $5 billion, faced the biggest problems. The WSJ analysis didn’t include savings-and-loan institutions, or so-called thrift banks.

Nearly one in three of the banks analyzed — or 2,182 — had construction-loan portfolios that exceeded 100% of their total risk-based capital, a red flag to regulators, although it doesn’t mean the bank is in danger of failing. Risk-based capital is a cushion that banks can dig into to cover losses.

Even more alarming, 73 of those banks had construction-loan delinquency rates of more than 25%…

The outlook for small banks looks pretty grim, according to the Journal. Corkery, Forsyth, and Wei wrote:

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, according to Zelman & Associates, a research firm. Over the next five years that figure could rise to 10% and 26%, which would amount to about $65 billion to $165 billion, Zelman projects.

Source:

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

KB Home Founder: Worst Recession Since World War Two

Eli Broad, the billionaire investor who founded homebuilder KB Home, told Bloomberg yesterday that, “This is the worst period of my adult lifetime,” while speaking about the U.S. economy. Bloomberg’s Erik Holm and Anthony Massucci wrote this morning:

“This is worse than any recession we’ve had since World War II,” Broad, 75, said in an interview yesterday… “I do not think things are going to get any better” before the next president takes office in January.

Broad also shared his views on the floundering housing market. He told Bloomberg that the sale of vacant, unsold homes could take “several years.” Holm and Massucci wrote:

“The problem is, people don’t believe prices have bottomed out,” he said. “You’ve got to induce people to buy houses” with federal policies including tax incentives…

“I think housing is going to continue to have a corrosive effect on consumer psychology and the economy in general to a far greater extent than people think, or even far greater than I thought about a month or two ago,” he said.

Source:

“Broad Says U.S. Economy in Worst Recession Since World War II”
Erik Holm, Anthony Massucci
Bloomberg, July 1, 2008

No End In Sight For U.S. Banking Crisis

The Wall Street Journal, with a little bit of help from federal regulators, managed to torpedo hopes earlier today that the United States was approaching an end to a banking crisis brought on by the housing bust. Michael Corkery, Jonathan Karp, and Damian Paletta wrote:

Until now, most of the damage to banks from the housing crisis has come from homeowners defaulting on their mortgages. But amid a dismal spring sales season for new homes, loans to home and condo builders are looking increasingly shaky. Banks have begun to dump them at what will likely be steep discounts, setting the stage for billions of dollars in fresh losses.

At a Senate Banking Committee hearing Thursday, Federal Reserve Vice Chairman Donald Kohn said:

As long as the housing market is on a downward path, as long as those prices continue to fall, I think there’s a risk that the losses could continue to mount on a variety of loans.

Federal Deposit Insurance Corporation (FDIC) Chairman Sheila Bair added at the same hearing that banks which aren’t diversified, or those with significant exposures to residential construction and development, are of particular concern. Bair said:

That’s where we are really seeing the delinquencies spike.

With no end in sight to the banking crisis, the health of the larger economy is at serious risk. Corkery, Karp, and Paletta explained:

The health of the economy is heavily dependent on the willingness of banks and other financial institutions to lend to consumers and businesses. Many banks have already taken substantial losses, and either will have to pare their lending or raise new capital to rebuild their safety nets. The Federal Reserve and Treasury Department have been pressing banks to raise capital so as not to further reduce lending.

The Journal referenced a report sent to clients Thursday by housing research firm Zelman & Associates which forecasts that over the next five years, U.S. banks could “charge off” as bad debt between 10% and 26% of their loans tied to residential construction and land assets, amounting to $65-$165 billion. During the last housing downturn of the late eighties-early nineties, charge-offs totaled around 10% ($31.6 billion, adjusted for inflation) of construction-related bank assets. Ivy Zelman, chief executive of Zelman & Associates, warned:

We believe this period of procrastination is nearly over.

It’s interesting to note that when looking at state percentages of total bank loans tied construction and development, Arizona has 36% of total loans tied to construction and development, Georgia has 34%, North Carolina is at 28%.

Zelman added that construction and development loans, as a percentage of total loans, are at their highest levels since at least 1975.

Oh my.

Source:

“Real-Estate Woes of Banks Mount”
Michael Corkery, Jonathan Karp, Damian Paletta
Wall Street Journal, June 6, 2008

U.S. Senator Mocks The System

I don’t know about you, but I’m starting to get this feeling that our Senate is evolving into that “legislative” body from the Roman Empire (not Republic, mind you) and from whom they derive their name. Well, at least they’re not assassinating each other in the hallways of the Dirksen Building (at least, not yet).

However, even those among its ranks are starting to mock the establishment and its growing reputation of being out of touch with mainstream America. The Wall Street Journal’s Damian Paletta wrote a great post for the Real Time Economics blog on Wednesday about Senator Jim Bunning (R- Kentucky) and his assault on the system. Paletta said:

The Senate Banking Committee plans to vote on legislation Thursday that would create a new regulator for Fannie Mae and Freddie Mac and allow the Federal Housing Administration to insure up to $300 billion in refinanced mortgages. Lawmakers plan to file up to 70 amendments during the committee vote, with 31 of those coming from Sen. Jim Bunning (R., Ken.).

According to a summary of all the amendments, Sen. Bunning wants:
• “to stop the bailout of the rich”
• “to prevent the bailout of illegal aliens”
• “to prevent the bailout of homeowners who used their homes as a credit card”
• “to stop the bailout of sex offenders”
• “to stop the bailout of drug offenders”

Another of Sen. Bunning’s amendments would change the name of the bill from “The Federal Housing Finance Regulatory Reform Act of 2008” to the “Bailout of Irresponsible Lenders and Borrowers Act of 2008.”

A good example of how to fight fire with fire, considering all the humorous initiatives coming from Capitol Hill these days. But, what would you expect from a Congress with an 18% approval rating, according to the latest Gallup poll?

Sources:

“Bunning Campaigns Against ‘Bailouts’ in Housing Bill”
Damian Paletta
Wall Street Journal (Real Time Economics blog), May 14, 2008

“Congress’ Approval Rating Ties Lowest in Gallup Records”
Lydia Saad
Gallup, May 14, 2008

Signs Of The Time, Part 11

You know American homebuilders are facing tough times when one of their affiliated organizations must sell their headquarters due to a lack of funds. According to the Associated Press yesterday, three years after moving into its new $3.5 million headquarters, the Home & Building Association of Greater Grand Rapids is selling the building. According to the piece:

Chief Executive Judy Barnes said the association is hampered by the weak economy, a sluggish residential building industry and declining membership. That triple whammy resulted in some pledges made toward paying for construction of the 15,000-square-foot headquarters going unfulfilled…

“Like the rest of our industry, it is a little slow right now,” John Overbeck, president of the association’s board of directors, told The Grand Rapids Press. “We’ve looked at it for the last year and a half, done everything we could to weigh our decision.”

Membership and staff numbers have reflected the fortunes of the U.S. housing market these past few years. When the trade group moved to the new headquarters in March 2005, it had more than 1,200 members and 19 employees. Later that year (and at the peak of the housing market), membership grew to around 1,400. Since that time, numbers have fallen to 980 members and 10 staffers.

Source:

“Home builders selling its posh headquarters”
Associated Press, April 6, 2008

Weird Housing Tales, Part 3

According to Reuters yesterday, a member of the luxury home builder Toll Brothers’ founding family is trying to walk away from an agreement to buy a new condominium— from Toll Brothers. Martha Graybow wrote in “Toll relative walks away from new condo – filing” that:

The daughter of Vice Chairman and co-founder Bruce Toll informed the company last month that she and her husband “did not intend to make settlement” on a $2.47 million home they had previously agreed to purchase, the company said in a regulatory filing.

A company spokesman was not immediately available for comment on the filing, which was made public last Friday.

CNBC real estate reporter Diana Olick also talked about this developing story in her “Realty Check” blog yesterday. Olick said:

According to the home builder’s proxy statement:

Prior to fiscal 2007, the Company entered into an agreement of sale to build and sell a condominium to Wendy Topkis, Bruce E. Toll’s daughter, and her husband for a purchase price of $2,468,075. In January 2008, the buyers informed the Company that they did not intend to make settlement on the condominium. The Company intends to pursue its rights under the agreement of sale.

Does that mean they’ll sue darling daughter? The company’s general counsel says they are pursuing normal procedures.

Daddy is quoted as saying she just changed her mind because she had another child and the place would be too small, but I’m guessing the 13 percent drop in Florida prices was screaming at her a little louder than the baby. So Wendy just adds to the company’s 61 percent cancellation rate in the Sunshine State…

Stay tuned…

Jim Rogers: Coming Recession ‘One Of The Worst’

Commodities investor Jim Rogers told Bloomberg yesterday that the U.S. economy is heading for a recession that may be the worst “in a while,” and investors should sell the dollar as global currencies weaken. The chairman of New York-based Rogers Holdings said from Singapore that:

It’s going to be one of the worst recessions we’ve had in a while because we had so many excesses going into it… It’s going to be bad for all of us as currencies come under more and more stress and we have more inflation in the world.

In addition to sharing his views on a possible recession, the legendary investor said that the governments of the United States and United Kingdom have been “lying” about inflation. Rogers noted that he’s sold both the dollar and the pound, and said:

I hope by the end of this year all of my assets will be out of the U.S. dollar… The dollar is a currency that’s terribly flawed and it’s going to be under duress for many years to come.

The co-founder of the Quantum Fund with billionaire George Soros in the 1970s re-iterated his belief that the commodities bull still has a ways to run, despite the weakness of the greenback. Speaking to Reuters by telephone from his home in Singapore last Thursday, Rogers said:

I sound like a broken record, but it ain’t over yet. It’s got a long way to go… It’s come a ways, but we may be in the fourth inning of a nine-inning ball game, to speak in U.S. baseball terms.

Commodities prices are going to go up no matter what happens to the U.S. dollar, even if it rises, because there are serious supply/demand shortages which have developed over the past 25 to 30 years.

Commodities: still swinging away

In addition, the American investor noted:

I am still short the investment banks in America, and these are the guys (Federal Reserve Chairman) Bernanke’s trying to save. I think that’s been the single area with the most excess — that and home-building.

Rogers recently moved to Singapore after selling his New York townhouse for $16 million on December 17, a gain of 150-fold from the price he paid for it, according to The Morning Call this past Sunday. The investor and author bought the property for $107,000 in 1977.