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Thawing the Markets, Part 1


Construction lending next shoe to drop.

I've been writing for almost a year that the next shoe to drop on US banks would be commercial construction lending. Today we look at some hard numbers.

Construction Lending: The Next Shoe to Drop
Minyanville's Why Wall Street Will Never Be the Same
The Bank Credit Analyst is one of the more reliable sources for information. They estimate that total losses from the current debt crisis could be anywhere from $1.1 trillion to $1.7 trillion. They estimate roughly half to be in the banking sector, or around $750 billion, and almost $590 billion of that has already been written off. That means that the $700 billion from the TARP (government bailout) program may actually be enough to handle the losses and inject some actual capital into the banks.

The losses from subprime and other mortgage-related loans are well known. Most of those losses are in the larger banks. What isn't understood as well are the potential losses to which smaller banks are in fact exposed in the area of construction lending. Lisa Marquis Jackson, writing for John Burns Real Estate Consulting, gives us some answers to the question of "how much?"

Outside of large home builders and developers, most lending for construction of homes and commercial property comes from regional and local banks. Look at the graph below. Since 2001, delinquencies had been rather small and well-contained. Then starting 18 months ago, the delinquency rates started rising.

Again, note that these are delinquency rates for business loans from banks and not for individual mortgages.

Click to enlarge.

Over 16% of loans made for condominium construction are now delinquent. Loans made for single-family home construction are only slightly more than 12% overdue. But that masks a much bigger problem. Single-family loans account for 86% of all for-sale residential construction loans outstanding.

The good news is that for the top 100 banks by size, single-family loans make up only 2% of the total. But that small portion totals $245 billion. And condos add another $41 billion. That puts almost $40 billion at risk of default at today's delinquency levels.

Click to enlarge.

It will be worse for many smaller banks, as they have larger commercial construction loan portfolios. As noted below, this may require some proactive action on the part of regulators.

Lehman at the Center

We now know the consequences of allowing Lehman Brothers to fail. The severity of the credit crisis was severely worsened by the failure of Lehman. Based on the results of the credit auction, sellers of protection will need to make cash payments of more than $270 billion, according to BNP Paribas SA strategist Andrea Cicione. Some funds may be forced to dump assets to meet the payment demands if they haven't hedged.

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