Builders Under Credit Squeeze for Loans to Build Homes

Funding for viable residential development and construction projects has been severely limited or blocked entirely at federally insured depository institutions

April 21, 2008
HousingZone

The mortgage credit crunch has spilled over into land acquisition, land development and home construction (AD&C) lending, increasing the challenges faced by builders in the current housing downturn.

"With private securities markets in disarray and banks retrenching, a bona fide credit crunch is underway," Bob Mitchell, a home builder from Rockville, Md. and former president of the National Association of Home Builders (NAHB), told the Senate Small Business Committee during a hearing on "Impacts of the Credit Crunch on Small Firms."

"This credit crunch actually appears to be worsening despite the concerted efforts of central banks here and abroad," he added. "Tighter mortgage lending terms have made it difficult for home buyers to obtain financing to purchase new homes. Likewise, there have been dramatic adverse swings in the cost and availability of AD&C loans for home builders."

Residential AD&C loans are used to purchase land; develop lots; build a project's infrastructure such as streets, curbs, sidewalks, lighting, and sewer and utility connections; and construct homes.

Presently, funding for viable residential development and construction projects has been severely limited or blocked entirely at federally insured depository institutions, which are the sole source of housing production credit for the small businesses that comprise most of the home building industry, Mitchell told lawmakers.

"The current financing quagmire for home builders vividly illustrates the importance of developing additional sources of AD&C credit," said Mitchell. "Furthermore, there is no secondary market for residential AD&C loans where community banks and thrifts could turn to help manage their balance sheets and obtain liquidity for additional lending."

He noted that a viable secondary market for AD&C loans would directly benefit builders and lenders by transferring risk away from lenders; increasing availability of funds so that projects could be more reliably completed; and mitigating the devastating impact of equity calls on builders, or transfers of partially completed projects to banks under capital and/or regulatory pressure.

To broaden sources of AD&C credit, Mitchell called for:

• Fannie Mae to ramp up activity in its AD&C loan purchase program and for Freddie Mac to create a similar program.
• Federal Home Loan Banks to improve AD&C liquidity by accepting housing production loans as collateral for the secured advances they make to member institutions.
• The Federal Housing Administration to help increase competition in the AD&C market by insuring the construction portion of these loans in order to attract new originators such as mortgage banking companies. "As in the case of the end-loan mortgage market, FHA could be a crucial stabilizing force in AD&C lending in turbulent times such as these," said Mitchell.
• Wall Street specialists to develop prototype private security instrument for AD&C loans. In particular, changes to tax provisions relating to Real Estate Mortgage Investment Conduits and Taxable Mortgage Pools could be helpful in securitizing construction loans.
• Banking regulators to take a balanced approach when evaluating bank lending, especially in regard to AD&C loans. "Small businesses, including small builders, are vital to the economy and arbitrary or unreasonable regulatory restrictions would only serve to harm many builders, and potentially, many banks," said Mitchell. "It would be ironic and tragic to have the positive work of the Fed undone by bank regulators taking a totally different vision and approach when it comes to lending matters."

Housing Stimulus Measures Would Help Consumers and Business

Meanwhile, stimulating demand for homes and stabilizing housing prices would do the most to relieve the financing and other business difficulties faced by home builders. The housing stimulus legislation moving through Congress contains key provisions that would help ailing home owners, restore consumer confidence, jump-start housing, stabilize financial markets and save jobs, he said.

"Two causal factors in the current housing downturn and the related credit crunch are declining house prices and excess inventory," said Mitchell. "A temporary home buyer tax credit, such as a provision in House bill H.R. 5720, could stimulate a wave of buying that could quickly reduce excess supply in housing markets and halt the dangerous erosion of house prices and mortgage credit quality."

Expanding the carryback of net operating losses beyond the current two years would help all businesses that have been hit hard in the current economic climate -- including financial institutions and manufacturers -- to weather the economic storm, make their payrolls and emerge from this downturn in a position to grow. It would also provide flexibility for home builders with large land holdings to reduce their inventories in an orderly fashion to stabilize home and land prices.

"The NOL carryback in Senate bill H.R. 3221 simply allows businesses to accelerate their claim of NOL deductions that under present law would be claimed in the future," said Mitchell. "The need for these deductions today is critical."

Finally, approving a temporary $10 billion expansion of the mortgage revenue bond program, which is included in both the Senate and House bills, would also help strapped borrowers seeking to refinance their own homes, he said. Expanding the reach of the program would allow it to have the largest effect particularly in communities experiencing the possibility of a wave of foreclosures or an extreme excess of inventory.

About NAHB:

 The National Association of Home Builders is a Washington, D.C.-based trade association representing more than 235,000 members involved in residential building, remodeling, multifamily construction, property management, subcontracting, design, housing finance, building product manufacturing and other aspects of residential and light commercial construction. Known as "the voice of the housing industry," NAHB is affiliated with more than 800 state and local home builders associations around the country. NAHB's builder members will construct 80 percent of the more than 1.08 million new housing units projected for 2008.