Housing Crunch

How would a real estate downturn affect you? Well, it starts with your bank . . .
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This story appears in the January 2003 issue of Entrepreneur. Subscribe »

As home construction continues to defy the recession, Cassandras at the Federal Deposit Insurance Corp. are worried about what happens when the boom ends.

In its fall report on the banking industry, the FDIC reported that the high level of home mortgages and construction loans by some community banks, particularly in the Southeast, may spell trouble for lenders in the event of a real estate downturn. If the industry is hit by widespread defaults, other borrowers will likely suffer. "Banks may have less of an appetite to add on other types of risk," says Robert R. Davis, managing director of government relations for America's Community Bankers, a trade group in Washington, DC. "So it pays to have more than one source of credit."

Banks most at risk, according to the FDIC, are those with more than 15 percent of assets invested in mortgages for new construction, considered the riskiest loans for their relatively higher degree of default. Half of the more than 40 community banks cited by the FDIC in Atlanta fall into that category. Nationwide, some 300 banks have more than 15 percent of their assets in construction loans.

Community bank advocates say the percentages alarming the FDIC don't tell the whole story about individual bank risk. "A construction loan on its own isn't bad," says Paul Pustorino, managing partner at Grant Thornton, a consulting firm in Boston. What matters more, he says, is each lender's expertise and the internal controls that keep risk to a minimum.

The type of loan matters, too. Loans that fund projects where the majority of units are pre-sold are much safer than so-called speculative lending with no contracted buyers. "There's much less construction lending of that type now," Davis says.

Entrepreneurs can relieve worries by calling their institution's management directly or tracking performance through business articles, annual reports, analysts' coverage and regulatory reports such as those from the FDIC. The stock market is another good gauge. "The security of a company indicates overall soundness," Davis adds, "especially if the bank is involved in real estate lending."

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Edition: July 2017

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