Let’s Make a Deal was a game show that originated in 1963 and starred Monty Hall. Audience members were offered a gift and then asked if they want to trade it for another gift of unknown value. Hilarity ensued when we watched people trade luxurious Hawaiian vacations for a pack of goats.
Tag: Construction Lending
As we all know, accordions are box-shaped musical instruments that bellow sounds without reeds. At CenterState Bank, we use accordion construction through perm loans to decrease credit risk, increase profitability and keep competitors at bay.
Commercial construction spending set new records in 2016. According to ConstructConnect total construction spending increased 4.4% last year (to $1,161T) and is expected to grow 6.3% in 2017. Much of that construction is being financed by the banking industry and a disproportionate share of that lending is originated by community banks. Community banks must be careful to manage construction risk and rigorously consider the risk versus yield in this lending category.
Back in June of 2013, the FDIC, OCC, and Federal Reserve jointly approved rules intended to implement new international banking standards. Known as the Basel III Capital Accords, Basel III uses a risk weighting system to determine the capital ratios for higher risk assets. Starting in 2015, all US banks that lend on “high volatility commercial real estate” (HVCRE) are required to hold more capital against such loans.
Construction and Land Development loans (C&D loans) drove a substantial portion of the loan growth at community banks between 2000 and 2007, especially for banks under $2B in assets. While C&D loan volumes bolstered total loan growth, these same loans resulted in substantial detraction from risk-adjusted return on equity (ROE). In fact, C&D loans were one of the major causes of bank failures from 2009 to 2011. Compared to their peak in 2007, current C&D loan portfolios are relatively small.
A flaw in many bank’s loan production process is calculating the profitability of a non-owner occupied construction loan that is for investment purposes. These are developer-led projects built for investment and thus subject to construction and market risk. Banks that measure the wrong metrics and don’t have a robust risk management process in place are doomed to create construction loans that detract from shareholder value. The problem is many banks and boards are not aware of this risk.