by Calculated Risk on 2/27/2007 06:24:00 PM

From the FDIC: FDIC Reports that Housing Slowdown Poses Challenge to Bank Loan Growth

The recent slowdown in residential construction could reduce the demand for mortgages and commercial real estate and construction loans -- activities that have been important factors in loan growth for banks and thrift institutions in recent years. That's according to the Winter 2006 edition of FDIC Outlook released today, which analyzes economic and banking conditions in each of the eight FDIC regions.

"While employment and income trends are positive in almost every region, the effects of the slowdown in residential construction activity are clearly visible," said FDIC Chairman Sheila C. Bair. "Going forward, insured banking institutions should pay careful attention to risk-management processes in this slower-growth environment."

Here is the conclusion from the San Francisco Region report:

Despite current strong economic and banking conditions in the West, increased reliance on historically volatile construction activity may stress local economies and the banking sector should the housing sector continue to weaken. An extended or sharp slowdown in construction activity could ripple through local economies and bank balance sheets and income statements. Although strength in other sectors—particularly the services sector—has emerged recently and could mitigate some of the negative effects of a slowing construction sector, elevated CRE and construction lending concentrations at FDIC-insured institutions will continue to be monitored closely for any signs of weakening in credit quality.

This is an understated warning. Especially concerning is the "elevated construction lending concentrations at FDIC-insured institutions". A CRE and C&D slump could exacerbate the economic problems caused by the housing sector slowdown.

Unfortunately nonresidential investment typically trails residential investment by three to five quarters. So it would not by unusual to see a CRE and C&D investment slump later this year with rising delinquency rates (See Investment Lags for an analysis of the lag times, as compared to residential investment, for equipment and software, and non-residential structures).

And here are the Commercial Bank Delinquency Rates released today by the Federal Reserve (through Q4 2006).

Click on graph for larger image.
Although commercial real estate delinquency rates are still historically low, they have started to move up. With the heavy concentration of CRE and C&D loans at FDIC institutions, a significant slump (like the early '90s) could pose a serious risk to these financial institutions.


As a review: this graph shows the YoY change in residential investment vs. nonresidential investment through Q4 2007. In general, residential investment leads nonresidential investment. There are periods when this observation doesn't hold - like '95 when residential investment fell and the growth of nonresidential investment remained strong - but it is reasonable, from a historical perspective, to expect a nonresidential investment slump in 2007.