Attracted by the potential profits from residential construction loans, commercial banks are looking to technology to reduce the risks of the business.
Commercial banks have been wary of lending to developers. Projects tend to go over budget, or be delayed, and sometimes the market for homes can dry up by the time a project is completed.
The upside is that construction loans are short-term, high-interest-rate facilities that generate fees and payments before all funds are disbursed.
The trick is to track projects in a cost-efficient way, said Philip C. Freeman, president and chief executive officer of Data Select Systems Inc. in Westlake Village, Calif., who has sold his company's software to some leading lenders.
"Construction loans are probably the most profitable loan a bank can make-you're turning funds fast with high returns, and you never lend it all out at once," Mr. Freeman said. "You can even support multiple loans with the same funds because of the incremental payments, but you really have to manage it well because it's a high risk."
Mr. Freeman said Data Select's software gives loan officers early warning via electronic mail if construction slows or a builder's insurance policies are close to their expiration date.
"The software tracks each loan and disburses the funds directly into the builder's account after each phase of construction is complete," Mr. Freeman said. "You don't loan beyond the collateral that's in the field at any given time."
Dan Schmidt, director of Norwest Mortgage's national builder division, which uses a customized version of the software, said construction lending is "a hot thing for us lately.
"We only lend when there is a borrower," the homebuyer. "Construction loans are more appealing in boom time-the key to builders these days is buying land-when the construction loan is in the borrower's name, it frees up their credit line and cash to buy more land," Mr. Schmidt said. "Construction loans tie us into permanent (mortgage) loans which makes us one-stop .... Usually, the more people involved, the more problems that arise."
Norwest Mortgage's national builder division made $5.6 billion of mortgages on newly built homes through November. Its annual record volume had been $4.3 billion in 1997.
According to the Department of Housing and Urban Development, the number of homes sold nationwide this year through September was 684,000, up 8% from last year.
"Before this automation, every branch was doing it differently, which made it a lot riskier," Mr. Schmidt said. "We're in the risk business, and by bringing consistency and conformity, you can minimize that risk."
Vance Venters, senior vice president at Wachovia Mortgage, Winston- Salem, N.C., said the use of software is paying off.
"Before, it was more of a manual process to track each loan," Mr. Venters said. "Now, loan officers can get on-line in the field and see exactly what has been done. It's a market-by-market basis now, rather than an entire housing industry."
A new feature of the Data Select software is the identification and tagging of construction loans for inclusion in financial asset securitization investment trusts.
The so-called FASIT security structure, introduced a year ago, allows lenders to pool construction loans with commercial mortgage loans. As the short-term construction loans are paid off, they can be replaced in the security pool with new loans.
But Douglas Weld, chief lending officer at Tokai Bank, Los Angeles, said this type of pooling is highly uncommon and unlikely to gain popularity.
"Investors just don't have the stomach for the risk involved in construction loans as well as securitization," Mr. Weld said. "If the market switches and goes into recession, most of those loans will not perform, or underperform, and that is very painful for investors."