Here comes another set of dodgy U.S. loans

By J Saft
March 11, 2009

jimsaftcolumn1— James Saft is a Reuters columnist. The opinions expressed are his own —

Banks in the U.S. face a new source of write-downs and failures in the coming year as loans made to developers to finance residential and commercial property development rapidly go bad.

And as these loans are old-fashioned and concentrated in smaller banks, their fate is particularly interesting as it indicates that issues with the banking system go far deeper than the so-called “toxic assets” belonging to the largest lenders that have thus far gotten most of the attention and government aid.

They are also a great illustration of the difficulties of stopping a housing and deleveraging crash.

Called Acquisition, Construction and Development (ADC) loans, they total 8.4 percent of all bank loans, just below a 30 year peak, and are used by developers to buy land, put in infrastructure and construct housing or commercial and office space.

And because they are dependent on a reasonably healthy real estate market — someone who is willing to buy or rent the properties — when projects are completed, they are now in deep trouble.

“Everyone in the media is focused on consumer foreclosures. What they’re not focused on is the builder developer foreclosures which are only in the early innings and which will continue to wreck havoc as these assets are liquidated at depressed prices. Until they are cleared there can’t be a stabilization in home prices,” said Ivy Zelman, a longtime housing analyst at Zelman & Associates, who thinks the pressure will cause “hundreds of banks” to be closed and liquidated.

“The Federal Deposit Insurance Corporation doesn’t have the funds to deal with all this. They don’t have the scalability to deal with all these problem banks. They can’t examine the smaller banks fast enough,” she said.

Zelman estimates that U.S. banks risk having to charge off an additional $84 billion of ADC loans between now and 2013, equal to a hit of nine percent of Tier 1 capital.

That is damage banks can ill afford just about now, given the rising trend in delinquencies on consumer and home purchase loans, not to mention a deteriorating outlook for commercial loans.

Non-performing ADC loans hit 8.5 percent at the end of the year, up from just 3.2 percent the year before. Loans delinquent between 30-89 days are also up, by 25 percent in the quarter to 2.9 percent. And developers, struggling to try to survive without reliable cash flow from sales, are drawing down on commitments from banks that are not secured. The percentage of unsecured construction loans drawn down hit 73 percent, above the peak seen during the 1990s real estate slump and a crucial sign of builder distress.


Of particular concern is the way in which ADC loans are concentrated in smaller and community banks, which tend to have long and deep relationships with local developers. ADC loans account for 47 percent of non-performing loans at small banks as against 14 percent at larger banks.

And you can’t blame mark-to-market or toxic securitizations for these losses. They are considered held-to-maturity and are not typically included in any complex securities.

Chris Whalen of Institutional Risk Analytics, which specializes in bank risk analysis, sees ADC loans as part of the difficulties banks face with commercial real estate, and believes that regulators will be forced to get tough with banks in forcing them to write down exposure to struggling firms and deals.

“It will be subject to an impairment test and than they will have to start charging it off. The regulators are already beginning to force the community banks,” he said.

And while smaller banks being closed by the FDIC may not get the attention of a bailout of a big bank like Citigroup, every failure depletes resources and hurts credit availability.

The FDIC fund fell by almost half in the fourth quarter alone, touching $18.9 billion as it set aside a large portion of money for actual and expected bank failures. The FDIC has said it needs a bigger cushion but moves to impose special fees on healthy banks will inevitably hit profitability and credit availability.

Democratic Senator Christopher Dodd, chairman of the Senate Banking Committee, is moving to introduce legislation that would more than triple — to $100 billion — the FDIC’s line of credit with the Treasury Department.

But even beyond bank failures, ADC loan woes point to the intractable problems of a real estate bust.

Banks, while trying to reduce their overall exposure to these loans, have been reluctant to pull the rugs from under borrowers because, as with a house foreclosure, they end up owning a hard-to-sell underlying asset. But more foreclosures are coming, and with them fire sales as banks compete with those developers who still are in business and with homeowners and with foreclosure sales to liquidate inventory.

That will drive land and real estate prices down further and suck others into what amounts to a negative self-reinforcing cycle.

That’s true for housing, true for banking and true for the economy.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund —


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Is Mr. Saft saying that in effect the financial industry is insolvent? I am wondering if Vikram Pandit is aware of that, and Bernd Bernanke? They still are hyping the banks as if the slump was only a temporary one.
And we haven’t even seen the credit card loans fail yet.
Oh bother.

Posted by Robynne | Report as abusive

Nearly three decades of society living beyond its means cannot be mended in a year or two. Expect ongoing pain, even a lost decade (Japan style) but without the savings cushion.

Posted by Assam | Report as abusive

The problem is that the banks are allowed to hold only a small percentage of their assets in real estate. (In the early 1970’s it was five-percent.) The fix for the small banks with this kind of loan is to let them hold these high-quality foreclosures as an asset; new construction, choice location… what could be safer?

Posted by Art Calck | Report as abusive

“Capitalism without bankruptcy is like Christianity without hell”.

Posted by QueZen | Report as abusive

I endorse Jim Cramers remedy…write down the principal on residential real estate loans to the market value securitize this value at a loan rate of 4%. Take the difference between the old principal and new principal and securize it as an asset with the full faith and credit of the government behind it (lets call this the Delta Security)and have it held by banks as a marketable security. IF the value of a home were to increase above the new principal amount financed at 4% ie: homeowner has a capital gain, at the time of the home sale this gain goes to pay off the Delta Security. Yes, losses will be incurred, some loans will still go under but we won’t be pouring money in the top of banks only to see it bleed out of the bottom..the hemorhaging will stop. Consumers will have gained CONFIDENCE that they won’t be put out on the street and they will begin to purchase again…slowly but surely this will arrest layoffs as companies see demand pick up.
Contiune to aggressively pursue, try in a public forum, convict where evidence warrants conviction and severely punish the wrongdoings to make it clear that committing fraud and stealing simply wrong and will not be tolerated by our society.

Posted by Craig | Report as abusive

Domino effect ? Or more poetically, The Fall of the House of Usher ?

Posted by Gregg&Brian | Report as abusive

I’m not too concerned about this bumpy ride. More frightening perhaps might be the next round – when the survivorship base will be artificially high, margins tight, and the money supply will start to contract. If you want more sap, you do not keep putting holes in the same tree.

Posted by Don | Report as abusive

If this isn’t a Dpression, what is it? Mr. Saft’s work is very excellent. I have a feeling we’re going to come out of this hole very different as a Country and as an Economy than anybody knows.

Posted by Andrew Franks | Report as abusive

Conditions are real and troublesome, but journalists – Saft included – are viewing this as their chance to write “the grand article”. The language they use now is grandiose and hyperbolic. “I see the real problem as no one else” kind of stuff. They are like war correspondents in a way, always seeking a dreadful, larger-than-life angle.

Posted by james | Report as abusive

Am I missing something? The way things are going these days, $84 billion is petty cash; who cares?

Posted by Pete Cann | Report as abusive

Didn’t Reagan teach you anything? Deficits don’t matter.

Posted by Ken | Report as abusive

“Capitalism without bankruptcy is like Christianity without hell”

Capitalism has bankruptcy allright. Just that American capitalism has no bankruptcy for the big and politically connected. Until the country is bankrupted.

Christianity, however, has no heaven and hell. Except in the minds of the believers.

Posted by TomK | Report as abusive

One thing that even the slowest learners must have gained from the current crisis is that the Treasury and Federal Reserve’s mantra is and will continue to be “inflate at all cost”. The US dollar is strong and the treasury yields are low. If Saft’s forecast is correct, I suspect that there will be something like a large black hole bank created to suck up all the struggling banks and put the whole thing on ice until the Fed and the Treasury can inflate away the problem. It is the approach that they took with TARP. While there may be a shortage of creativity on the part of the Treasury, there will be no shortage of Treasury securities.

Posted by Leusk | Report as abusive

We are now reaping the true “benefits” of a world economy that was built not on real asset values but on derivatives on top of derivatives on top of illusions of value. It was financial magic by realtors, Wall Street bankers and insurers worldwide. Now you see your money, now you don’t. Poof!
Now dear taxpayers, kindly send us more money to fill our coffers and don’t dilly dally around about it lest you also lose your pot to P in.

Posted by Ray | Report as abusive

So once again the giants become bigger and more wobbly with the help of the government and the little guys get the shaft. I believe that the economy will recover and this country will come out stronger in the end but it looks like we have a lot to do before we get to that point. Thanks for your article.

Posted by Craig Coal | Report as abusive

I see that a Marriage of corrupt government and business had a lot to do with making this bubble and until we stand up and change it they will just prop it up.

Posted by Craig Coal | Report as abusive

In an interesting side conversation with my loan officer at a well known [large] bank, that officer suggested that there were two shoes to drop at the same time. Not only are the commercial loans expected to default at a higher rate, but the 5 year ARM jumbo loans as well, starting this summer. There were a large number of those ARM loans issued in 2003-2005, and they are going to adjust upward in greater numbers starting in June. The combined effect is going to be negatively nauseous [imagine vomiting, but no projectile, uhh, dry heaves…]due to a completely illiquid market.

Posted by Hatteraskman | Report as abusive

I can do my infinitesimal part to make it hurt even more.
Capital One Bank changed their credit card rules recently; so I cancelled my MC with them. I am looking to transfer the open balance to another card company so I can stick it to ’em just a little bit more.

Posted by RFL | Report as abusive

It’s become very fashionable to become a doom-sayer. They are competing against each other who will say more depressing, gloomy, hopeless … prediction.
I am sure there might be some positive aspects, too. But hey, who will listen to them, they sound ridiculous these days

Posted by Marco | Report as abusive

Another excellent article James – and a threat I had not previously appreciated (though commercial property on this side of the pond is tanking with more write-downs due at the end of Q1).

Surely this once again makes the case for imposing a restriction on loans that effectively says the asset has to be valued on the basis of its potential rental income (discounted lifetime value I think they call it).

The warm feeling home owners get (when they think they actually own the pad – unlike renters who feel like they are squatting) might command an emotional premium but should not command extra leverage.

Keep telling it like it is Mr Saft.
Father Ignatius Brown

Posted by Father Ignatius Brown | Report as abusive

If I hear anymore of FDIC complaining that they are short of funds to insure deposits I WILL PULL ALL OF MY CASH out of the banks where I hold it. With the huge leverage that banks use on deposits this will take out quite a chunk of money out of the banking system and precipitate its decline. Ben Bernanke and the so called US Government better listen up to me.

Posted by Sam | Report as abusive

When will we make the banks reduce the interest they charge on credit cards? There is no reason they should charge 20–25–30%!!!!

Get congress to work on this NOW

Make them reduce all cards to 9% or lower!!! NOW.

Posted by Rosemary McNally | Report as abusive

The way I see it is this country needs a middle class with sufficient income to purchase what they need (and sometimes want) without over extending themselves using credit. Otherwise they drive prices up beyond what is reasonable given their income. So until prices of all assets are in line with middle class income the economy will not recover. The other thing needed is for all countries to have the “right” to produce what they need, if they are able, within their country/locally without it being considered protectionism. The US simply cannot exit with a fair standard of living on the wages paid for service jobs. Otherwise, the economies of the world will be like water….seeking its own level which means the US will live with a much lower standard of living. At the same time there needs to be some real discussion of how many people this planet can support at a decent standard of living and we all need to focus on this instead of just what “I” can have…oh and Christians live in the here and now with peace, comfort, and the love of God thru the good times and the bad times..He wants this for EVERYONE…can to join Him???….

Posted by Clarity | Report as abusive

James, I love your stories.
I think this economy is like a volcano eruption – everyone will inevitably get hurt in one way or the other.
We all just happen to live on the volcano of the capital markets. The alternative is to move to a cave and hunt tigers for food.
Living on the volcano, we all have to remember to be prepared, and just go into executing the plan B.
Everyone lives like this – get fatter while the times are good, and live off that fat while they are lean.

Posted by ForverSpB | Report as abusive

This is the (inevitable) end product of removing Western Nations from the Gold Standard and replacing the fiscal responsibility of managing a gold reserve with the irresponsible maneuverings of fiat money. The Gold Standard has within it’s brilliant simplicity the One thing lacking in our current fiscal system…. RESPONSIBILITY! You cannot “print” more gold when you have spent it all… Cash on the Barrelhead.

The fractional reserve system that allows banks to loan money that they do not possess. Basing our economies on “Consumerism” and not genuine Capatalism; how long can Any economy survive when you expect people to buy the same things Every Year with slight cosmetic changes to justify the purchase? How many television sets do you think the average household must buy This year to save the economy?

All the while governments keeps printing more fiat money and throwing it about randomly while quoting the “Spend, oh God Please SPEND!” mantra. Did Any of them ever read the history of such places as say… the Weimar Republic? How long until people in America take their paycheck home in a wheelbarrow? This brings back the argument of the Gold Standard vs. our current “system”

When my grandmother carried on about how much a gallon of milk or a hamburger cost when she was young; she thought she was simply reminiscing, in reality she was teaching me about hyperinflation. A hamburger is still a hamburger… the product value remained the same and yet cost (both cash value and the time on the job required to pay said cost) went up. Why? The cows did not become greedy or organize themselves into Unions. The Burger didn’t get Bigger…. the Dollar got Smaller.

Why did the dollar get smaller? “Inflation…” but what is inflation? Inflation is another term for devaluation.
If the entire world contained only one Apple, it would be very valuable,but if we can just manufacture a billion of them…. it becomes worthless…. just like our money.

As for this “Stimulus” actually working… who are they trying to kid? “FDR saved this nation from the depression by spending!” They say, so “we can too!”

What a magical pile of steaming…

FDR managed this country through the depression by spending. That part (out of context) is correct, but what is obviously being overlooked is How this happened.
FDR did not simply throw billions of dollars out there and shout “Spend!” from the Whitehouse roof. The money was spent in hundreds of public work projects. Projects like the TVA which improved the infrastructure of the nation and expanded it’s industries. New hydroelectric dams were built to provide ecologically sound power systems around the nation etc. Do we see this kind of effort being made now? Then how can we expect the same results?
The simple fact is that it isn’t FDR in the Whitehouse and this isn’t the New Deal, this is our future being thrown away by political hacks who are patently unfit to be trusted with anything as important as pumping septic systems. (I only hope that that analogy doesn’t end up being too apt.)

Posted by Ian W. | Report as abusive

I agree I also think we are far from the credit crisis being over. Not to mention credit card defaults and more housing woes. How the government is going to cover all the bad debt is beyond me. It sounds like foreign governments in the EU are already tapped out and will just have to play a wait and see about how it goes. I agree with them that having the government go further in debt is probably not a good ideal at this time. Some things just have to happen and I believe it should be allowed too. Even though it will be painful. We will be better for it because hopefully we will have learned.

Posted by John Scott | Report as abusive

There are not enough banknotes available to pay bank depositers who want to withdraw their money if a run on deposits were to occur. Our nation’s debts (and others) will be paid off in inflated currency. Other countries will inflate their currencies hand in hand with ours. The canard that “We’re saddling our grandchildren with future debt.” is relative. We’re paying off the debts of our grandparents with inflated money. Inflation is eternal. A mason jar filled with Krugerrands burried in the back garden might be helpful. Also a loaded shotgun. Peace.

Posted by Robespierre XIV | Report as abusive

[…] Here comes another set of dodgy U.S. loans – Reuters BlogsBanks in the U.S. face a new source of write-downs and failures in the coming year as loans made to developers to finance residential and commercial property development rapidly go bad. And as these loans are old-fashioned and concentrated in smaller […]

Posted by Capital Home Loan – MBIA Debt-Guarantee Split Sparks Hedge Fund Lawsuit (Update1) – Bloomberg « Capitals Loans | Report as abusive

[…] Here comes another set of dodgy U.S. loans – Reuters BlogsBanks in the U.S. face a new source of write-downs and failures in the coming year as loans made to developers to finance residential and commercial property development rapidly go bad. And as these loans are old-fashioned and concentrated in smaller […]

Posted by Capital One Home Loan – U.S. May Use Capital Injections to Help Banks Sell ‘Bad’ Assets – Bloomberg « Capitals Loans | Report as abusive

Another solid piece, Mr Saft. One factor which is I think somewhat intriguing in the present improvisational drama is that thus far the contractionary/deflationary forces are in relative balance with the inflationary forces being generated by the various ‘bailout’ efforts. One wonders how long this dynamic balance will sustain itself and, if and when it tips, which way it will, in fact, tip. Quite the cliff-hanger.

Posted by Atomik the Duck | Report as abusive

James, the core of the problem is the fractional banking system and the financial meltdown which is shaking the system at its core. Another $100 billion dollar loss is not going to matter that much in a multi trillion dollar financial system constructed from the thin air of credit. In the past year tens of trillions of ‘dollars’ has been wiped out in stock and property devaluation.

Get your head back to the epicentre of the financial tsunami. Collapse of property market, global infection with collateralised mortgages, jammimg and deleveraging of credit markets.

The central banks which have been creating credit out of nothing and then ‘lending’ it to borrowers who must pay it back with interest in cash are now resorting to creating money out of nothing.

In the midst of this stupidity the sheeplike herd of investors are grovelling for any morsel of hope to drive stock markets up in the midst of the “great recession”.

Governments are in a situation of trying to save their drowning partner and in the process they may get drowned too. The UK looks halfway there and the US is probably not far behind.

The tsunami has hit us and you are telling us about a 3 foot wave that may be breaking on the shore.

Posted by Gregory | Report as abusive

James: Alan Greenspan is the only responsible for the financial institutions crisis: In the 90s, when he could have acted, he DID NOT REGULATE these financial institutions the way it needed to be regulated, Now, because of him, We are suffering the worst recession since the 1939s. The blame is all his.

Posted by George O. Wilson VII | Report as abusive

The financial Apocalypse continues. Is there a second half recovery coming? Absolutely. In the second half of the next decade. Maybe.

Posted by James M. O’Meara | Report as abusive

The assets would not be difficult to sell if they were appropriately priced. They would be appropriately priced had we not artifically manipulated the price I would say on a macro level. If we had devoted our resources, decades or years ago, whenever, to develop new products and supporting new markets, we would already be out of this crisis. Instead we are drawing capital out of the system. It is like using your children’s organs to keep the grandparents alive. We would have been better off doing nothing. Let people make enormous returns from enormous risk, and folks will do what comes naturally.

Posted by Don | Report as abusive

An economic crash is better avoided at all costs. We have Greenspan’s ‘New Era’ thinking to blame for getting us into this mess. Greenspan blames the end of the cold war, with the newly developing centrally-planned countries converting to dynamic exporters and flooding the US with cash.

Posted by Pru Shields | Report as abusive

“When will we make the banks reduce the interest they charge on credit cards? There is no reason they should charge 20–25–30%!!!!

Get congress to work on this NOW

Make them reduce all cards to 9% or lower!!! NOW.”

Demand drives price. If we all cancelled our credit cards the rates would drop. I’ve cancelled my Capital One Bank MC – it’s easy to do – you can too.

Posted by RFL | Report as abusive

>I WILL PULL ALL OF MY CASH out of the banks
My 81 year old mother in law recently decided to do just that. We don’t know what will happen in the near future. I closed an IRA and will out the money in commodities. Our financial system is in serious trouble and I don’t think the current administration has a clue about how to fix it. Obama saying don’t put your money in your matress? I can’t think of a better reason to do that. JMO

Posted by Eagle | Report as abusive

The Federal Reserve is a private company, not federal nor a reserve just a good name to fool everyone. Printing money by fiat without reserves allows for profound abuse. Bring the gold standard back and allow the markets to set prices not banks. It is through the manipulations of money and credit by these bankers that is responsible for this ridiculous bubble and now all they are trying to do is maintain market prices. It won’t work no matter what they do. The charade is over.

The value of the economy is the quality of jobs and industry. Let’s debunk the “trickle down” Reagan voodoo economics. It is the wages of labor that pay for interest the lifeblood of banks, these wages “trickles up” through investment instruments which are then trade on the market. To pump the markets fiat money was created and then pumped into the economy through garbage loans. Now the banks are reaping what they have sowed and we the taxpayers are bailing them out. In fact I don’t even see it a bailout, I see it as a con job. These banks will not survive. Our government is the biggest joke of all without our consent they back these crooks.

Posted by Wupta | Report as abusive