Credit Screws Tighten on Worthy Builders

In George Bush’s final address to the nation he uttered the universal lament of man, "There are things I would have done differently if given the chance." That one phrase of humble regret and loss of second chances is the foil to real time confidence and action.

For builders, the second chance would have probably resulted in a slow wind-down of building activity in 2006 and the hoarding of cash. Then a four year vacation in Costa Rica on a fishing boat with a grand finale reappearance on the housing scene in 2010. “There are things I would have done differently if given the chance.” Understandable.

The last 10 to 15 years have provided a pretty nice ride for most builders with only a few lows and some unbelievable highs. Coming off the greatest housing boom in American history, then free falling into one of the worst housing markets since the Depression, public sympathy is shallow for the builder’s devastating reversal of fortune.

On any given day, the news is littered with examples of building companies pushing daises after herculean efforts failed to save them from the housing recession. Many of these casualties are small to medium-sized builders and their demise only reported or noticed locally.

The loss of the small and mid-size builder, who accounts for about 70 percent of new-home construction in the U.S. (the most interesting part), will forever change the housing landscape. Each downturn culls the unworthy from the builder rosters, usually striking the smaller builders first and working its way up the food chain to the medium-sized builders. A sizable reduction of this builder segment may change the housing mix to a future domination by national builders.

The large public production builders have the best platform from which to maintain a downturn with better capitalized coffers. They have suffered as well taking huge hits on stock prices and severely curtailed construction, but for now, most of the big guys can meet their obligations. They are in a much better position to survive than smaller private builders.

What is the casualty count to date? No one knows for sure but the National Association of Home Builders estimates that 20,000 builders – about a fifth of the total nationwide – have shuttered their operations in the last two years.

The credit screws were tightening all through 2008, shown by a NAHB survey, as lenders started reassessing existing builder and developer loans (single family construction loans, land acquisition and development loans, and multifamily loans). New appraisals often showed declining values. The survey showed consistently across the three loan types that about 63 percent of borrowers were asked to reduce principal with pay downs or pledge additional security. Often times the increased lender requirements were funded through the builder’s personal assets. Such personal capital depletion is particularly concerning and potentially devastating for small to medium builders and developers.

As the survey demonstrated, banks have tried to renegotiate construction loan terms with builders for some time, but nothing like the credit shutdown that has recently shaken many builders to their core. No longer is it good enough for a builder to make his payments to stay in the good graces of their lenders.

For lenders today real estate as collateral and builders as borrowers are considered the untouchables and the race to close the book on that outstanding debt is on. Bank regulators have lost patience with lenders who are not acting aggressively on “old debt.” “Get it off the books” is the mantra heard most often even if it means saddling the lender with unwanted real estate to manage and liquidate.

“The reality is, we’re seeing conditions in home construction and home finance that are the worst since the Depression,” said Steve Fritts, associate director of risk management policy at the Federal Deposit Insurance Corporation. NYT

Bank-owned developed and undeveloped lots and houses in all stages of construction dot the suburban landscape in the once growing boom areas, mostly in the Sun Belt. And there is still hundreds of billions of dollars in real estate that is still in danger of default. “As defaults and delinquencies rise, home builders, once prized banking customers, have become pariahs. Even builders who are up to date on their interest payments or still managing to sell houses are getting trampled.”

“They’re not distinguishing the track records of one borrower against another,” John Fioramonti, a real estate consultant in Scottsdale told the New York Times. “If you’re a builder, you are a bad risk.”

Until recently, banks had largely tried to keep past-due borrowers afloat, in the hope that a housing recovery might pave the way for them to repay their debts in full. But now builders are more often left feeling betrayed by their lenders as the credit pullback accelerates. Lenders are under greater pressure today from federal bank regulators and their own shareholders to curtail lending to a faltering industry, no matter what the past relationship or credit worthiness.

With the economic outlook darkening, lenders are stepping up foreclosures of troubled loans. Banks are reassessing the borrower and the real estate security and a reduction in the borrower’s cash position or a decline in the value of the real estate securing the debt is cause for automatic default, even if payments are current.

“Zelman & Associates, a housing analysis firm, estimates that losses on land and construction loans could eventually reach $165 billion, one reason federal regulators are pushing banks to come to grips with the problem. When we talk to regulators now, they say they’ve lost patience,” said Ms. Zelman, who is chief executive of Zelman & Associates.

In this climate, keeping loan payments up to date — something many builders are struggling mightily to do — is not necessarily any protection.

With thousands of small and midsize builders facing “no way out” with the new credit screws tightening, the outlook for the industry is dire. “The downturn that we’re experiencing right now is so unprecedented that there’s really no business model that works,” Joel Shine, a real estate investor told the NY Times.

Is federal relief a possibility in the form of a tax credit for new-home purchases? “Some analysts believe such a bailout would artificially re-inflate home prices and encourage further building in a saturated market. ‘What is the public good for that?’ asked Thomas Lawler, a housing analyst and former vice president for risk analysis at Fannie Mae.”

Meantime, new construction has collapsed with new starts the lowest since 1991. Developers and builders have cut staffing to the bone, sending millions of workers in search of employment.

Where this will land the housing industry at the end of the recession is hard to predict. Most in the industry agree that the picture will be quite different from what we’ve experienced over the last few decades. A new and different industry may emerge. One thing is for sure … the winner’s circle is shrinking.