Nothing is more menacing than a skunk
with its tail in the air. A skunk's spray can
reach 12 feet, so avoiding it is the best
course of action. We all know that the
housing sector stinks right now, but like the
person who walks around a corner and gets
blasted by the skunk, knowing what to do
next can quickly reduce the lingering odor.
For community bankers heavy in single-family residential
construction, times are tough, but that doesn't mean nothing can
be done to improve the situation.
To begin, we all have to get real with our projections. Home
sales are down 37% from this time last year and the overhang of
unsold homes sits at 11 months. The silver lining is that slower
home sales have also led to a corresponding slowdown in
construction. In order to reduce the overhang, we needed to
choke new supply down to a trickle, which has now happened.
As of the last month, construction of new single-family homes fell
to its lowest level in 17Ys. We also have to realize that
condominiums will remain a problem for even longer in some
markets. Condos now account for 1 in 8 homes in the country
and in some hard hit areas, unsold units are outnumbering sales
(for the past 12 months) by a ratio of more than 4-to-1. In Miami
alone, the overhang will likely take 5Ys to be fully absorbed. This
problem has pushed foreclosures in some buildings to 50% of
units. Understanding there is no quick fix here and taking into
account the strength of the future real estate market is critical.
Next, we suggest bankers update appraisals on larger
exposures (or those having difficulty). While no one likes to hear
bad news, the sooner one can take action with a borrower, the
sooner the bank's interests can be protected. As one banker
recently said, "if your best customer isn't paying on their loan as
agreed, they are a liar and have ceased to be the best customer."
Third, even "pillars of the community" can have difficulty and
stop paying on their loans. When they do, bankers should move
quickly to take action. Rich people may have money, but they
also utilize leverage, so the first bank in is usually the first (and
perhaps only) one to collect. Waiting rarely helps the situation.
Another thing bankers can do is to get proactive. Do not sit
and wait until a loan stops performing to attack a growing
problem. If you find an area or sector you are lending into has
begun to soften, get out and visit even strong borrowers and be
proactive. Understanding where risks are forming and taking
immediate action will help protect shareholder value.
By now, all bankers know that regulators want to see the
ALLL needle pointing higher. Don't wait for an examiner to show
up on the doorstep to tell you the reserve will have increase.
Bankers should also be prepared to suspend dividends if things
get rocky in order to replenish capital and reserves.
FOMC Chair Bernanke has even warned bankers to remain
proactive in capital-raising efforts. This is particularly true if your
institution has high exposures or area/sector risks are increasing.
Capital has become harder and harder to come by, but worrying
about this now, getting a plan in place and being prepared is
advised.
Bankers should also work to improve overall risk management
processes and reporting. Being able to identify, monitor and react
quickly to exposures and weakening customers are critical at this
juncture.
Incorporate liquidity-adjusted pricing ("LAP") on your
construction exposures. LAP is used by regulators to calculate
the expected price a seller would get if they were to sell a house
immediately in a given area. While LAP can sometimes be close
to recent market sale prices when conditions are calm, it is
particularly useful in areas where conditions are weakening. As
demand for housing falls, prices fall and time on market
increases. The more this occurs, the more liquidity-adjusting the
price of sale becomes important. In some markets, the difference
between last sales price and LAP can be 8% to 12%.
Once a skunk sprays you, it can take some time to remove
the smell. It may also require trying many different remedies to
find the right solution. Trying different remedies in construction
lending is also very important right now. As it appears the bottom
of the cycle will not be reached until late 2009, bankers will have
to work carefully to avoid getting sprayed.