Deutsche Bank: Construction Loan Defaults Coming

Interesting piece from Deutsche Bank on rapidly deteriorating Construction loans. DB predicts that “construction loans will be the epicenter of bank loan problems”

• By far the riskiest type of loan product in bank portfolios;
• Substantial portion represents loans to homebuilders;
• Market currently penalizing properties with vacancy issues extremely severely;
• Newly constructed (or only partially constructed) properties are the poster children for vacancy problems in CRE;
• Values of most newly constructed properties are down massively;
• Expect extremely high default rates and extremely high loss severity rates, both likely to be in excess of 50%;
• Total expected losses of 25% or more.

In a reversal of the Residential Real Estate market, the exposure for large money center banks is low — smaller regional and community banks have the highest construction loan exposure.

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Construction loan exposure for smaller banks has nearly doubled since 2004
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Construction loans are structured with upfront reserves — meaning that it takes much longer for CRE defaults to occur.  Low short-term interest rates also means reserves can last longer — BUT, as DB notes, Once reserves are exhausted, defaults will skyrocket.

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The current delinquency rate is 15%, but may head much higher
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Source:
The Outlook for CRE and Its Impact on Banks
Richard Parkus
Deutsche Bank, 30 July 2009
http://gm.db.com/IndependentResearch

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