With real estate construction booming, the government Monday issued a pointed reminder of the risks of speculative real estate lending.
Citing the results of a survey, the Federal Deposit Insurance Corp. said examiners were worried about the level of speculative construction lending at 25% of nearly 400 banks studied. Only 18% of the banks were singled out during a previous survey six months ago.
"Currently, there is no cause for alarm, but our results show that certain underwriting practices, especially involving construction and commercial real estate loans, should continue to be monitored carefully," FDIC Acting Chairman Andrew C. Hove Jr. said.
The warning came as construction in many markets is matching that of the go-go 1980s. That building boom led to the industry's biggest crisis since the Great Depression, saddling many banks with loans on projects that didn't attract paying tenants.
"The commercial real estate market is about as hot as it has ever been," said Philip M. Wharton, chief executive of Property Information Exchange Inc., which tracks the real estate investment market.
Vacancy rates have been dropping, fueling demand for new space, he said. He also noted that more investment capital is being allocated toward commercial construction.
The FDIC blamed fierce competition for the increasingly lax standards on construction loans that were identified in the survey, which covered the six months ending Sept. 30.
Still, the FDIC said it found few overall problems with underwriting practices. About 90% of the 1,233 banks supervised by the FDIC showed no material change in underwriting practices since their last exam. Nearly 6% tightened standards, while 4% loosened them, the agency said.
Bankers said the speculative lending warning was justified, noting that lenders are taking more risks to increase returns to stockholders.
"A lot of banks have just got excess funds and are under severe pressure to continue their quarter-to-quarter growth," said Sonny B. Lyles, senior vice president and chief credit policy officer at Bank United, Houston.
Lenders may feel they have the expertise to make safe speculative real estate loans, he added, but they could suffer if the economy sours. "We may have had 79 months of economic expansion, but it hasn't gotten easier to know what is going to happen next year," Mr. Lyles said.
Banks make speculative loans when they finance construction of a project even though the developer has few, if any, commitments from buyers or tenants. During the 1980s, speculative lending contributed to a building boom that far outstripped demand for office space. As a result, many developers defaulted on their loans.
"Speculative construction lending isn't as out of control as it was in the 1980s, but it is getting there in certain markets like Atlanta, Denver, and San Francisco," said Mr. Wharton, of the Property exchange. "These projects offer much higher returns, but they are also much riskier."
However, Paul W. McGloin, executive vice president of CoreStates Bank, Philadelphia, said lenders are more aware of the risks involved with speculative lending.
"Bankers' memories are still very clear on what can happen with speculative building loans," Mr. McGloin said. "I think it is a lesson that has been learned."
"Nothing that is going on in the marketplace suggests that anybody is out of control," agreed Mitchell M. Roschelle, a partner at Coopers & Lybrand. "Capital is just starting to find its way back into the market after the late '80s."
In the survey, which is conducted twice a year, the FDIC found that 11% of the nearly 700 banks that actively make commercial real estate loans frequently failed to consider repayment sources other than income generated by the property. This is a 3% increase over the six months ending March 31.
Kevin M. Blakely, executive vice president for risk management at KeyCorp, Cleveland, said he was surprised at this finding.
"That was a fundamental part of the breakdown in the late '80s," he said. "You have to look beyond the project itself for other funding possibilities in case things don't work out. That's just sound underwriting."
FDIC examiners also warned that agricultural lenders could experience trouble in the next several years. Because the government is phasing out subsidies on wheat, feed grains, rice, and cotton, farmers that depend on these payments could find it increasingly difficult to repay loans, the FDIC said.
The report found that 15% of the 520 agricultural lenders studied had portfolios "substantially" tied to these four crops.
