Construction Loan Woes Hitting Minnesota Banks

by Alex Stenback on November 6, 2007

Good piece over at The today which details yet another emergent problem in the real estate banking sector – Construction loans.


As can be seen from the table above (click for bigger) Minnesota is home to four five of the top 20 banks with the highest percentage of non-performing construction loans (versus total assets.)

For those unfamiliar, a construction loan, whether for a private residence or a commercial building, is basically a line of credit which is drawn upon periodically to finance construction.  In other words, construction loans are not long term financing vehicles, and are only intended to bridge that gap between an empty lot and a set of blueprints, and a finished building which can be financed through traditional channels.

So why the trouble?  The article points out two major factors that have caused the problems.  I think there is a third (I’ll get into in a minute):

Subcontractor Risk:

A major worry is "subcontractor risk," since a subcontractor can place a lien on the property at any time. If neither the borrower nor the lender have proof that the general contractor paid a subcontractor for completed work, the subcontractor’s lien will probably not be lifted

And "Concentration Risk,’ where a bank has too much exposure to a single builder:

Coast Bank of Florida (held by Coast Financial Holdings (CFHI) made news back in January, when it announced problems with 482 construction loans to individuals who had contracted with the same failed builder, Construction Compliance, Inc., to build homes for investment purposes.

To be sure, these factors are important, but there is perhaps a third element at work here: Credit Contraction Risk.  Here’s how it works.

When a construction loan is approved, the lender confirms that the borrower has been approved for permanent financing – this way they know that when the building is complete, they will be paid off.  Clean, simple, and relatively risk free for the construction lender – the end loan is approved, so as long as the home is finished according to plan, what could possibly go wrong?

Here’s what:  You could have a bunch of construction loans whose end-loan approvals were sub-prime, Alt-A, or Jumbo loans, which have all but vanished during the ongoing mortgage meltdown/Credit Crunch.

Then what you have is a huge problem – a portfolio of (now permanent) construction loans to potentially iffy borrowers, who won’t be all that happy to pay you Prime + 1 in perpetutity, or will simply walk away from the project in mid-stream because they can’t get financed.  Imagine a real puke-fest going on at many of these institutions right now over this very thing.

What’s the take-away?  From the article:

The continuing housing crisis may cause more construction companies to suffer and banks to feel the pain. As always, it is a good idea to monitor the Financial Strength Rating of the bank or thrift that holds your deposits.

While you might be comfortably under the FDIC’s insurance limits, if you or someone you know are running a business, nonprofit organization or managing municipal accounts, it is quite possible to lose money when a bank fails, as we recently saw with two recent bank failures.

Banks Hit by More Construction Loan Woes []

{ 2 comments… read them below or add one }

Teresa Boardman November 7, 2007 at 6:14 am

Just when I thought it was safe to read the new again. :)

Callie June 30, 2008 at 11:09 pm

I am a builder that had a sales contract to build a new home. I was held out on a $65,000 second draw only to be fired. We have been to trial and were have found not to have breached in any way. Here lies the problem: Our attorney who was completely incompetent filed a statuory lien against our own secured interest. The sales contract was assigned to the lender to use as collaterol. We signed numerous docs. at closing (const. – perm loan). Needless to say, the borrowers are now in bankruptcy, they have not reconveyed to the permanent, the house is still incomplete, the building inspector is working with the District attorney for an eviction and yet with $158,000 remaining to be paid out of the construction funds, the bank – SunTrust Mortgage has not defaulted them. It is a mess! I didn’t even mention the part where I got a $55,000 judgement against the borrowers for willful and malicious slander in which we just won again in summary judgement in their bankruptcy proceeding.

Good article by the way!


Callie Calhoun

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