Keeping That Hard Hat Handy: Community Bankers Find Challenges of Residential Construction Lending and Other Commercial Real Estate Finance a Variable Affair

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Last year saw the country's largest home builders backing out of options or contracts on land that hadn't been built on or developed yet.

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D.R. Horton, Inc., the country's largest homebuilder, ended its fiscal year on Sept. 30, 2007, with a net loss of $712.5 million. A hefty portion of that came from writeoffs of deposits and pre-acquisition costs related to land option contracts that the company chose not to pursue--$107.3 million for the year, and $40.3 million just in the company's final quarter.

To Horton and other large builders, houses aren't homes, but inventory. When it doesn't move, it has to get moved. So big builders began selling homes in certain markets at cut-rate prices, simply to clear the balance sheet and hope for better times. But in the real estate market, ripple effects abound. Part of the fire sale was seen in Horton's own backyard, Fort Worth, Texas. Community banker George M. Bradford, president at Fort Worth's National Bank of Texas, saw these ripples hitting his own customers, the smaller builders that his $113.7 million-assets bank finances. Bradford was one of eight community banking executives taking part in an ABA Banking Journal roundtable with members of ABA's America's Community Bankers Council in late October, and in follow-up discussions in December. The group discussed local building and credit trends, as well as regulatory and exam issues in construction and commercial real estate credit.

"We don't do business with volume builders," continues Bradford. Indeed, ten years ago, he says, the bank had perhaps two real estate loans on its books at all. But with competition, the bank evolved its balance sheet, like so many other community lenders, and today about 65% of the bank's loans are in construction and development and other types commercial real estate. Two-thirds is owner-occupied, mostly in-market.

So what happens in Horton's backyard is what happens in First National's world, pretty much.

"The D.R. Hortons of the world are the real volume builders, and they're losing their shirts right now," says Bradford. "So they're dumping their homes, and that's been causing some problems, because the custom builders that we finance can't."

The typical builder that First National works with puts up perhaps four new homes a year, keeping two on "spec."

"We've got one builder who just stopped building, until Horton got all of their inventory in his area sold," says Bradford. "Now he's back building again."

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Bradford says that the smaller builders, having somewhat more flexibility than a large player like Horton, are still doing relatively well in his area. They are tending to play more conservatively, cutting the spec homes they commit to.

"Times are generally good, and [people are] buying homes," says Bradford. Much of what's moving is in the midsize range. "We think the really large homes and the really small ones will not move," he adds.

The strong Fort Worth economy also accounts for continuing viability among the construction and development and commercial real estate deals that the bank is seeing. Noncurrents in these areas are quite low for First National and business continues to come along.

"It's amazing how well it's held up," says Bradford, in spite of high foreclosures in the market, brought about through the subprime lending crunch. Indeed, there's enough volume out there that Bradford can afford to be selective.

Case in point: an $18 million participation deal for a residential development shopped to Bradford recently. The bank considered going to its legal lending limit--about $1 million--but took a pass. Bradford says the development's lot size and home size just seemed too large for the current market's appetites.

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