A Promising Sign for Housing

 | Dec 13, 2012 | 6:00 PM EST
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I've written a lot this year about the headwinds facing housing and a recovery in the group, as well as the status of nonperforming mortgages. In this column, I'll review the status of construction-and-development loans.

C&D loans are provided by banks to developers so they can structure raw land into building lots and parcels with access to roads, water, electricity, sewer and cable television. The developers then have a subsidiary company build the homes, or they can sell the lots to builders or individuals.

The development process is laborious and expensive. When the housing bubble burst in 2007, the banks ended up needing to take back the collateral they had provided for the C&D loans, because the developers couldn't sell the lots to make payments.

Today the value of the land -- now being carried as "other real estate owned" (OREO) collateralized by these loans -- far exceeds the value of the homes they are also holding in OREO. This is the asset category assigned to foreclosed real estate for bank bookkeeping.

Currently, the total value of foreclosed homes held by the banks is about $8.5 billion, and the value of the raw and partially developed land is about $13.5 billion.

When the demand for newly constructed homes increases, existing partially developed land offers a great opportunity for builders. That's because, much of the time, the capital-consuming work has already been done. As a result, this is an area to be monitored for increases in real activity in the banking sector -- and recently we've seen some good performance here.

In the summer of 2010, the value of defaulted C&D loans peaked at about $18.5 billion. Since then it has decreased steadily, coming to about $13.5 billion as of the end of the third quarter. So the banks have been selling their developed-land foreclosures.

However, they have not been financing these properties for the buyers. The value of performing C&D loans held by the banks has also declined steadily during this same period -- from about $350 billion to $200 billion today.

These data indicate that the banks are either selling these assets for cash or financing them with some other category of loan -- maybe commercial and industrial. It's not possible to ascertain this from the call reports. But we know they are not restructuring the existing loans with the original borrowers, because the value of restructured loans has also been declining for the past few years  

In any case, the recovery rates on these loans have gone up steadily and dramatically -- from about 2.5% three years ago to about 27% today. That is a huge increase, and it indicates the demand for land started ramping up about a year after the equities markets bottomed in early 2009. 

All told, the data indicate that the equity and debt capital for construction and development loans is coming from outside the banking industry, or being funded by the banks through C&I loans.

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