Smaller builders getting increasingly squeezed by bank loans

A brother of mine who works with homebuilders as a subcontractor was telling me last night what a difficult time he's been having getting paid for work in the past -- sometimes as long ago as 2006, which certainly makes it difficult to pay his staff! So is this the behavior of insensitive companies or is something larger amiss -- such as a major cash squeeze which is impacting smaller builders even harder?

According to writer Michael Corkery in the Wall Street Journal -- who is an excellent writer covering the real estate beat -- what's happening now is the much-predicted 'second wave' of mortgage defaults now impacting the building community -- as well as the banks who funded their projects:

In the first wave of the housing crisis, homeowners across the U.S. lost their properties to foreclosure. Now, many of the nation's small and midsize home builders are on the ropes...

Now, plummeting home sales across the U.S. have left many builders with unsold inventory and land. Some are falling behind on interest payments, beginning to face foreclosures on developments...sometimes reaching into their own pocket to keep operations going. Many smaller builders financed their developments with so-called recourse debt, which means that if they default, banks could seize homes, cars and other personal assets.

The U.S. government is now scrambling to contain the damage from the housing market's unraveling. On Wednesday, federal regulators cleared the way for mortgage-finance giants Fannie Mae and Freddie Mac to inject as much as $200 billion into the mortgage market, a credit-boosting move that could help builders' flagging sales.

"There are a lot of companies on the brink" of bankruptcy, says Ricardo Chance, a managing director at KPMG Corporate Finance LLC, who is helping troubled builders in the Midwest, Northeast and Arizona restructure their businesses.

Builders' problems are now threatening losses for small and medium-size regional banks. Muscled out of the mortgage business by large national lenders, many of these banks flocked to construction lending as the housing market boomed. Though these institutions were generally less exposed to the subprime-backed securities that have generated billions of dollars in losses for national banks, they are the front-line casualties when builders and developers can't make their payments.

Delinquencies on loans to build single-family houses reached 7.5% of the value of all such loans in the fourth quarter, up from 2.1% a year earlier, according to Foresight Analytics, an economic and real-estate research firm. There's likely more pain ahead. The Commerce Department reported this week that permits for new housing construction, a barometer of future building activity, fell 7.8% in February to the lowest level in 16 years. Also this week, the Federal Deposit Insurance Corp. said it had "increased [its] overall concern" about banks with high concentrations of construction loans, particularly those for residential developments, its strongest warning to date about these banks...

Analysts say as many as 150 banks could fail over the next three years. By comparison, about 900 banks and savings-and-loans associations failed from 1990 to 1995, according to the FDIC...

Analysts worry that losses from home-construction loans could contribute to a possible credit squeeze in small towns and cities across the U.S. "You are going to see a contraction in lending not just for construction, but for auto loans and credit cards," says Gerard Cassidy, a banking analyst at RBC Capital Markets. "In our view, it's the big shoe to drop on the banking industry this year."...

Every housing downturn prompts some builders to go bust, but the current slump is sinking some seasoned companies..."Even rock-solid, generational businesses are taking desperate measures," says Jerry Howard, the chief executive of the National Association of Home Builders. While the industry group does not track bankruptcy filings by its members nationwide, its Atlanta affiliate estimates that as many as 20% of local builders are behind on interest payments...

These builders' struggles mean that when housing demand recovers, the industry could be more consolidated and dominated in many markets by large builders such as D.R. Horton Inc., Lennar Corp., Pulte Homes Inc., Centex Corp., KB Home and Toll Brothers Inc. While many of these publicly traded builders are coming under pressure from their banks amid a deepening credit squeeze, most have cash reserves that may give them an edge over smaller builders in renegotiating credit agreements with their lenders...

Not so for Whitlatch & Co., an Ohio builder profiled in detail for this story. If you have access to the Wall Street Journal, I highly recommend you read the article in its entirety, as it puts a face on a "greedy developer" who was anything but and the many steps he took to save his company, his employees and his investors.