Some interesting data collected by www.bankregdata.com for banks under $2 billion in assets: construction and development (C&D) non-performing loans percentage by state. Let’s start with the worst offenders.
Nevada, Washington, Hawaii, District of Columbia, Idaho, Puerto Rico, Georgia, Illinois and Oregon all even worse than Florida and California that have saturated the media. Sure, they are smaller economies but I would not underestimate the economic importance of Georgia, Illinois and Washington. And if you run screens, cheap banks from these states pop up all over the place.
The information is not perfect: some banks loaned cross states and does not disclose how large a percentage of total loans was C&D. What I can tell you though, is that almost every potentially cheap Nevada, Washington, Hawaii, District of Columbia, Idaho, Puerto Rico, Georgia, Illinois and Oregon bank that I have analyzed had some big non-performing loan issues triggered by C&D loans. To reiterate, and I am sure it will not be last time I say this, construction and development loans are bank killers.
It is not difficult to see why. If 20% of your loans are C&D and 20% of them are non performing, right there you have 4% of your loans non performing with some of the worse potential severity. If you add home mortgage, helocs, CRE, consumer credit loans… there is not margin of safety buying a bank with more than 6% of non performing loans whatever its capital ratios, but I would raise the bar even higher if the bank has a large C&D percentage.
And when C&D are pervasive in a whole region, things get much worse. Think Ireland. Banks desperately trying to sell their real estate owned from foreclosures while their competitors are doing the same, driving real estate prices lower and lower well below the replacement cost that in theory should have been the long term equilibrium. But in the short and medium term capital ratios suffer so banks do not lend making things even worse … if government does not intervene. A depression.
What about the well behaved, any surprises there?
Texas and New England? Home to some of the worst offenses in the 80s? For those who think that this crisis is completely new just read Peter Lynch’s “Beating the Street” and how he makes fun of New England bankers and warns about buying banks just because they reached new lows (how low can it go!):
How many people lost substantial amounts of investment capital when they bought on the bad news coming out of the Bank of New England after the stock had already dropped from $40 to $20, or from $20 to $10, or from $10 to $5, or from $5 to $1, only to see it sink to zero and wipe out 100 percent of their investment – Peter Lynch
It is almost as if they learned their lesson twenty years ago but I would not bet on it. And this is a good introduction to the next part of Charting Banking because we are going to review an indicator invented from the difficulties of Texan banks in the 80s that is used to anticipate those troubles: the Texas Ratio.