First, it should be noted that the QT shows that bank loan portfolios look a lot healthier than they did just a few years ago.

However, as James Vickery, an assistant vice president in the Federal Reserve Bank of New York's Research and Statistics Group and April Meehl, a senior research analyst in the Bank's Research and Statistics Group, wrote in the post “Just Released: Bank Loan Performance Under the Magnifying Glass”, the data show that loan performance on construction loans is much more sensitive to the economic cycle than is the performance for commercial real estate backed by income-producing properties. [see chart].

The data also show that only about 4 to 5% of loans backed by income-producing properties were delinquent even at the peak in the wake of the Great Recession, while the nonperforming loan ratio for construction loans other than for single-family homes peaked at around 16% in 2009.

Why are construction loans so much riskier? Vickery and Meehl take a stab at answering that in their post.

A key reason is that a new real estate development is generally a speculative investment not currently producing a stream of lease income to meet mortgage payments. The ultimate value of the development is often highly uncertain because the ultimate stream of lease payments depends on future local economic conditions when the building is completed. Furthermore, real estate development is often concentrated in areas experiencing rapid real estate price appreciation; these areas may also be more likely to experience a larger decline in real estate prices if a downturn comes.

That, of course, investors and lenders already knew from the start. The difference is now they have the data to back it up.

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WASHINGTON, DC–Construction finance, especially from banks, is viewed in the capital markets as the proverbial canary in the coalmine, in that it is usually the first type of lending to dry up when the cycle matures or otherwise signals a slowdown ahead. It makes intuitive sense — why would a lender risk capital on a project where the future cash flow is so uncertain?

Now, new statistics in the New York Fed's recently released Quarterly Trends for Consolidated US Banking Organizations provide more insight into this reasoning.

To date, the QT report has only tracked loan balances and performance for five broad categories: residential real estate, commercial real estate, commercial and industrial loans, consumer loans, and other loans, the Liberty Street Economics blog noted in a post about this development.

But starting this quarter, the report is breaking down down loan portfolios into smaller subcategories. One example is that the QT report now breaks out the mortgage performance of several types of income-producing commercial properties and of construction loans backed by properties still under construction or development.

First, it should be noted that the QT shows that bank loan portfolios look a lot healthier than they did just a few years ago.

However, as James Vickery, an assistant vice president in the Federal Reserve Bank of New York's Research and Statistics Group and April Meehl, a senior research analyst in the Bank's Research and Statistics Group, wrote in the post “Just Released: Bank Loan Performance Under the Magnifying Glass”, the data show that loan performance on construction loans is much more sensitive to the economic cycle than is the performance for commercial real estate backed by income-producing properties. [see chart].

The data also show that only about 4 to 5% of loans backed by income-producing properties were delinquent even at the peak in the wake of the Great Recession, while the nonperforming loan ratio for construction loans other than for single-family homes peaked at around 16% in 2009.

Why are construction loans so much riskier? Vickery and Meehl take a stab at answering that in their post.

A key reason is that a new real estate development is generally a speculative investment not currently producing a stream of lease income to meet mortgage payments. The ultimate value of the development is often highly uncertain because the ultimate stream of lease payments depends on future local economic conditions when the building is completed. Furthermore, real estate development is often concentrated in areas experiencing rapid real estate price appreciation; these areas may also be more likely to experience a larger decline in real estate prices if a downturn comes.

That, of course, investors and lenders already knew from the start. The difference is now they have the data to back it up.

Save

Save

Save

Save

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