See here, for a "line-of-credit" description of construction lending. Mortgages to home purchasers are long term credit. Loans to developers or builders are short-term working capital lending. The normal expectation is a construction loan will be cashed out from proceeds of the first purchaser's mortgage loan. The normal expectation for credit to a development is meeting some form of scheduled progress payments, as parts of the project get cashed out (i.e., what in the normal course of events would have been required of Nedegaard and his Ramsey Town Center LLC's borrowing -&- debt service). PiPress reports:
Housing slump stings area banks
Six from Twin Cities among 20 in the U.S. most exposed to failing construction loans
BY JENNIFER BJORHUS
Article Last Updated: 11/13/2007 06:58:35 AM CST
An intensifying housing recession is zapping community banks across the Twin Cities - not with belly-up mortgages, but with failing construction loans for the housing behind them.
Since homebuyers slammed on the brakes, developers, builders and families across the region have been defaulting on construction loans for all manner of new housing, leaving community banks holding the bag.
Six of the 20 most-exposed banks in the country, ranked by the percent of overall bank assets that are in nonperforming construction loans, are based in the Twin Cities, according to New York-based investment rating agency TheStreet.com Ratings. Nonperforming means the loans are unlikely to be repaid.
They are: Key Community Bank in Inver Grove Heights, Vision Bank in St. Louis Park, Citizens State Bank in Hudson, Wis., Community National Bank in North Branch, BankCherokee in St. Paul and Lake Community Bank in Long Lake.
We recognize that bank. They were the ones with Sandison and Peterson, bank officers dabbling on their personal account in an unlicensed title company with Bruce Nedegaard, when Nedegaard was on the hook, via RTC LLC, to that bank for millions. And they were the ones letting the security bleed out, piece by piece, without the principal of the debt being accordingly amortized.
So, you tell me, I'm ignorant of it, what's the definition of "a nonperforming loan."
Back to the PiPress reporting:
[D]evelopment deals became a bread-and-butter business for many of the small guys during the housing boom. It's not clear how many more shaky construction loans are coming due. With many developers and builders in dire straights [sic], the banks are changing course, with some targeting other commercial lending.
Failing construction loans at the six Twin Cities community banks ranged between 3.6 percent to 5.2 percent of the banks' total assets in the second quarter, according to Philip van Doorn, TheStreet.com Ratings bank analyst who ranked the banks nationally based on call reports filed each quarter with the Federal Deposit Insurance Corp., which regulates banks.
Those are high concentrations of nonperforming assets - one FDIC official called the percentages "extreme" - although they represent just $37 million. By comparison, the ratio of nonperforming construction loans to total assets for all banks nationally was 0.06 percent in the second quarter.
That puzzles me, the $37 million number, where it came from. Nedegaard alone, in one deal with Community National Bank of North Branch, had that big an arrearage, so it seems like a low-ball number in any industry-wide context. Perhaps an error in reporting? Or editing error? Possibly, "billion" was meant. Resuming:
"I've been in the business 40 years, and I've not seen it like this," said Gene Haberman, president of Citizens State Bank in Hudson, which has $201 million in assets and nearly $10 million in construction loans unlikely to be repaid. "It was like a line was drawn in the sand, and all the building stopped. No one was prepared for that."
Nonperforming loans either are in default or have stopped accruing interest, but van Doorn's nonperforming count also likely includes many loans in foreclosure. Construction loans include commercial and residential construction.
To be sure, Citizens State Bank and the others are not failing and remain well capitalized, according to van Doorn's review. They all have tier-one leverage ratios - roughly a bank's core capital as a percent of total assets minus some liabilities - above the FDIC's required 5 percent.
Still, the high concentrations are troubling, particularly since the housing recession doesn't appear to have hit bottom and could worsen as more loans come due. Four of the six banks lost money in the second quarter, some because they beefed up loan loss provisions. At the very least, the failing loans and housing recession spell a rough patch for community banks as they change the way they do business.
[...] Haberman and the other bankers insist customers have no need to worry. They're working with their construction borrowers, they said, and the loans pose no threat to financial stability. They dismiss the trouble as a market issue.
If "working with their construction borrowers" is the term for what Community National Bank was doing with Nedegaard, myself, I'd worry.
I'd worry about mature experienced bankers who after years in business claim to be flumoxed by a market bubble bursting.
I'd worry as a banker about the way Nedegaard was allowed to continue, were I a banker in the loan consortium absorbing pieces of the Nedegaard lending activity that Community National packaged out.
I'd worry as someone with cash in such a bank as Community National. In a sock between the mattress and box springs might be safer for storing the cash than in some "banks" were it not for FDIC insurance for the first $100,000 on deposit and at risk in an institution. Anyone still with more than that in Community National, or with any CD holdings there not covered by FDIC protection, should consult his financial advisers quickly. Back to PiPress, with understatement featured:
Haberman and Marshall MacKay, president and CEO of the Independent Community Bankers of Minnesota, say banks may have become too casual with their real estate underwriting.
"I guess the obvious answer has to be yes, because if we knew what we now know, we would have put bigger margins in," Haberman said. "We followed traditional guidelines."
Others disagree standards got lax. The bankers didn't predict how quickly the high-cycle would end, they say.
That Citizens State Bank in Hudson popped out near the top of the list speaks to how the construction loan problems cut across a range of community banks. BankCherokee, Lake Community Bank (formerly State Bank of Long Lake) and Citizens State Bank all are 100-year-old institutions, not the kind of startup banks one might expect to be more vulnerable.
Such as Vision Bank. With assets of just $25 million, the St. Louis Park bank opened in 2005 specifically to fund commercial real estate deals. Brian Weimer, Vision's chief executive, said most of his trouble is one group loan, called a participation loan, that Vision Bank joined to finance a housing development that isn't in the construction phase yet. He wouldn't name the project.
Bad construction loans led Key Community Bank in Inver Grove Heights last year to shut down a residential real estate finance division it opened five years ago and cut back sharply on new housing construction loans. As of June, it still had about $4.6 million in bad construction loans. David Bjerknes, Key's senior vice president, said the bank has been "very effectively" working through the process to secure its collateral.
[... Then our poster child for bank woe] The troubles of another bank in the group are well known. Community National Bank in North Branch made headlines in July for its $35 million group loan to late developer Bruce Nedegaard for his failed Ramsey Town Center housing development. An attorney for that bank blamed the Ramsey Town Center deal for the bank's high concentration of bad construction loans.
FDIC regulators say they can't explain the cluster of failing construction loans in the Twin Cities. Federal banking regulators last year urged caution to small and midsized banks in managing risk.
Don't blame the project. Blame the guy(s) at the switch. Blame anyone who gave Nedegaard liquid cash during 2005 - 2006 without tying on strings. Pioneer Press earlier reported about money diverted into Swiss bank accounts. Probably in that time frame.
Letting that kind of mischief go on under your nose, does that sound like prudent banking to you?
Who else knew of the seriousness of the Nedegaard situation - his thinly capatilized meanderings into the Ramsey Town Center affairs, and all? Tammy Sakry reported City of Ramsey knew. James Norman appears to have told her that.
So what did our prudent city officials do to preserve the security of Ramsey Town Center park plans and promised millions of developer dollars for that precise park development purpose?
What did they know? When did they know it?
What did they do? When did they do it?
Who were the parties responsible, and what were their responsibilities to the City and its taxpayers? Who knew what and should have been communicating with others, (besides the Community National insiders and Nedegaard, who appear to deliberately have not communicated as much as I would expect other bankers in the package would have wanted)? City officials at fault? Only city officials? What about well paid consultants, what were their actions and responsibilities?
Such questions are something to examine in detail in future postings.
And will Pulte and D.R. Horton go broke? I doubt that for now, but how long will the housing market slump, what exposure do those mega-firms have in different housing sectors, what's their inventory control - how much built stock are they sitting on that they'd want to move and are they keeping some crew activity going to avoid layoffs and unemployment insurance spiraling - and the big question, what's their credit situation with their lenders and their situation with local affiliated builders to whom they may have given credit? Debt service without cash flow can erode liquidity quickly. As publicly traded companies Horton and Pulte had to do some reporting, it might be informative, but aggregated figures might not be enough to predict such things, depending upon the firms' exposures in different parts of the country, and depending on which regions are the worse markets now and over the next six months.
I took the above photo Aug. 21, 2007. There was Hovnanian effort then at Town Center, along the west side of Rhinestone near Hwy 116, the Symphony at Town Center effort.
Unfinished symphony, so far. But it is new shared-wall inventory. Hovnanian is building in 2007 and not sitting still, and I think building there is continuing now, this quarter. It could be a local-affiliate builder with working capital taking the risk, apart from the parent firm. But Hovnanian recently was reported as one of the nationwide builders facing trouble - or at least aggressively unloading inventory:
Hovnanian Orders Drop
By Nicholas Yulico
TheStreet.com Staff Reporter
11/6/2007 10:13 AM EST
Hovnanian Enterprises (HOV - Cramer's Take - Stockpickr - Rating) reported a 10% drop in quarterly new-home orders and said sales significantly deteriorated in October.
Some analysts now expect the Red Bank, N.J., homebuilder to implement another round of steep price cuts to clear its large inventory of houses. More than half of Hovnanian's orders in the recent quarter came during the company's heavily hyped "Deal of the Century" weekend sale.
For the fourth quarter ended Oct. 31, Hovnanian's contracts totaled 2,781 homes, down 10% from a year ago in the fourth quarter. Cancellations rose to 40% of contracts from 35% in the third quarter.
During the quarter, the company used cash flow from home sales to reduce its debt by $390 million.
Hovnanian attributed the increased cancellation rate to the tightening of mortgage underwriting standards, which has lead [sic] some customers to terminate their contracts due to an inability to obtain mortgage loans.
The results were better than expected, but more pain could lie ahead, according to Bank of America analyst Daniel Oppenheim. He expected a 25% year-over-year decline in orders.
"Sales likely fizzled after Hovnanian attempted to pull away incentives from its 'Deal of the Century' promotions the weekend of Sept. 14-16," Oppenheim said in a research note.
During the "Deal of the Century" sale, Hovnanian sold homes at fire sale prices to get rid of inventory. The company said after the sale that it had 1,700 contracts from the weekend.
"We expect that Hovnanian will reintroduce discounts similar or greater than before in order to maintain sales and generate positive cash, since competitors who matched its temporary promotions actually set new market prices," the analyst said.
I am not one to second guess a fortune 500 firm, but the discounting and promotions as reported seems to have been going on at Town Center, by Hovanian, with this photo also from Aug. 21. "Fire sale prices" indeed. It looks like used-car lot signage.