Working paper examines construction loan losses at failed banks from 2008 to 2013

A working paper focused on construction loan losses, and potential drivers, at more than 275 banks that failed between 2008 and 2013 was released Wednesday by the Federal Deposit Insurance Corp. (FDIC).

For the paper, part of the FDIC Center for Financial Research working paper series, researchers from the FDIC and Federal Reserve used proprietary loan-level data from more than 15,000 defaulted construction loans at more than 275 banks that failed between 2008 and 2013 to explore the extent to which observed losses during a severe downturn are driven by the characteristics of the loans, the originating banks, and the local markets.

Previous to this paper, they note, data has shown that noncurrent loan rates for acquisition, development, and construction (ADC) loans at U.S. banks were more than double the noncurrent rates of other types of mortgages during both the Great Recession and the 1980 to 1994 banking crisis. They also noted that researchers have found that banks with heavy exposures to ADC loans were more likely to fail during both crises.

For this paper, the FDIC and Fed researchers reported finding close ties between loss rates and certain loan characteristics as well as market conditions both at and after origination. They also said the risk of higher losses on construction loans is influenced not only by the originating bank’s behavior but also by the behavior of other local lenders in the market.

“This finding has important implications for how lenders and regulators manage risk through the real estate cycle,” they noted. “We also find support for existing regulatory guidance regarding higher capital requirements for construction loans, specifically for land and lot development loans.”

CFR working papers, according to a cover note, contain findings and conclusions that may be preliminary and subject to revision.

Determinants of Losses on Construction Loans: Bad Loans, Bad Banks, or Bad Markets? – FDIC CFR working paper