With all the talk over the last year and a half about commercial real estate [CRE] being the next shoe to drop while not dropping, this post is about reminding us of what was really the issue. This can give perspective of the relative order of magnitude of future problems and their consequences.
The real bank killer has been construction and development loans [C&D], with the next possible culprit not even close. This is a chart detailing the type of collateral for real estate loans of closed banks.
SFR: Single Family Residential (Source)
Careful with those construction and development loans:
- They are large
- with short term maturities
- no cash flow to soften the blows
- collateral price has collapsed
- and no demand in the near term for all that construction
So the problem with C&D loans is part the probability of default but even more consequential is its severity. Other types of loan problems can be mitigated by refinancing but it is much more difficult with C&D in the middle of a recession.
For most of the banks that I have stumbled upon with recent non performing assets surprises their issue was still related to C&D (ie: CBNK a couple of days ago). And most of their C&D loans were residential since the size of the commercial C&D market is dwarfed by the residential market.
Concluding, as an investor you have to be really sure of a bank underwriting standards (LTV in particular) when they have 20%+ of their portfolio in C&D loans even with good capital ratios. And reading 10Ks will probably not be sufficient, so I personally prefer to avoid those banks.
Disclosure: No positions