Off The Charts: Like Subprime Mortgages, Some Construction Loans Are Delinquent

BANKS across the United States, particularly the smaller ones, have become dependent on construction lending just as that area of the economy is weakening and the number of bad loans is growing.

Figures compiled by the Federal Deposit Insurance Corporation and released last week show that both midsize and small banks had construction loans outstanding that were greater than their total capital. A decade ago, such loans were equal to only a third of capital for those banks.

For most of this decade, that was a good strategy. Construction loans proved to be very profitable, particularly for smaller banks as competition from larger banks and securities markets eroded their position in areas like mortgage lending and credit card issuance.

Now, however, more than 3 percent of all construction loans are classified as being nonperforming, or have borrowers that are behind on their payments. That is the highest proportion in a decade.

Such problems are not spread evenly across all banks, of course. “When you look at the regional impact, the areas that were the booming condominium markets, like South Florida, have shown a surge in delinquency rates,” said Matthew Anderson, a partner in Foresight Analytics, a real estate market analysis firm based in Oakland, Calif.

“I think there will be a wave of bank failures in the not-too-distant future,” he added, “although probably not on the order of the 1980s and 1990s. You had a lot of high loan-to-value lending going on in markets that have soured significantly.”

When construction loans go bad, they can go very bad, in part because it can take a long time to slow them down after markets begin to weaken. Construction projects, once begun, are useless if not finished.

So even though construction spending began to decline in mid-2006, the volume of construction loans on bank books has continued to rise, hitting a record $616 billion at the end of September, up 13 percent from a year earlier. Mr. Anderson estimated that construction loans for single-family homes fell 10 percent over the period, but that was more than made up by increases in loans for condominiums and apartments, and by a surge in commercial construction.

It is somewhat easier to slow spending on single-family homes, since a developer planning a 50-home project can leave some of the homes unbuilt if demand dries up. But a planned 20-story condominium building cannot be topped off after 10 floors are built.

“A lot of the biggest construction lending problems are in markets that are already weak,” Mr. Anderson said. “Having weak projects hitting a weak market is just adding to the price pressure in that market.”

In early 1991, in the last big real estate downturn, the percentage of construction loans that were either on nonperforming status or behind in payments hit 18.5 percent, nearly six times the current level.

For anything like that to happen now, commercial real estate markets — including office buildings and stores — would have to weaken significantly.

That is unlikely to happen unless a severe recession arrives, but the possibility has worried federal bank regulators. In 2006, they proposed rules to restrain such lending but backed off after banks objected. The policy that finally came out did little more than warn that “rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the advent of adverse changes in commercial real estate markets.”

The problem, if it comes, is not likely to affect big banks as much as smaller ones. Banks with more than $10 billion in assets have lower concentrations of construction loans now than they did at the end of 1989. But banks with less than that amount of assets are more than twice as dependent on construction loans as they were then.

E-mail: Norris@nytimes.com.

Tag Cloud

External Information

Additional Information

Where Am I?