updated 3/5/2008 11:58:56 AM ET 2008-03-05T16:58:56

Loans to homebuilders and other developers are the latest slice of the credit market under duress, and analysts say banks could face hundreds of millions of dollars in losses as a result.

As commercial and residential real-estate prices decline, banks of all sizes face a growing number of loan defaults from builders unable to sell houses, and from developers whose malls and other properties turned out to be less desirable than anticipated.

These problems, if they worsen, are likely to rattle shaky credit markets and could cause more banks to fail in the coming years. They come after the prolonged real estate boom made such lending seem exceptionally safe, and default rates had been low.

Those seemingly safe loans are proving to be anything but secure. For example, Dallas-based Comerica Inc. set aside $108 million for loan losses in the fourth quarter of 2007, primarily because of bad real estate development loans the bank made, particularly in California and Michigan.

Construction and development loans are loans made to builders for properties such as strip malls, office buildings and residential developments. They have been a key source of profit for small and midsize banks.

The percentage of those loans that are 90 or more days past due rose to nearly 3.2 percent at the end of 2007, up from less than 1 percent a year earlier, and is now at levels not seen since the early 1990s, according to the Federal Deposit Insurance Corp.

At a community bankers’ conference on Wednesday, FDIC Chairman Sheila Bair said banks that were cautious about their lending should be able to weather the slowdown. Those that weren’t so careful won’t be so lucky.

“If you competed fiercely for deals, turned a blind eye to the loose terms that were available in the market or took on significant undiversified concentrations, you may well get hurt if we have a sustained slowdown in real estate,” she said, according to remarks prepared for the Orlando, Fla. meeting.

Other regulators agree. Comptroller of the Currency John C. Dugan told lawmakers Tuesday that “smaller banks that have exceptionally large concentrations in commercial real estate loans — and there are many of them — face real challenges in those parts of the country where real estate markets have slowed significantly.”

Many of those banks are smaller ones that shifted their lending toward construction and commercial real estate after facing tough competition from national players in the residential mortgage market. Bank examiners will step up their scrutiny of such lending activities, Dugan said in a speech in late January.

“The industry is overexposed to this sector of the real estate market, and it’s going to lead to hundreds of millions of dollars of losses over the next two or three years,” said Gerard Cassidy, a banking industry analyst with RBC Capital Markets in Portland, Maine. “Lending standards were unusually weak during the boom period.”

Some banks are already taking a hit. On Monday, shares of Marshall & Ilsley Corp., a Milwaukee-based bank holding company, slipped after a Goldman Sachs analyst cut his rating on the bank’s stock, citing the company’s exposure to construction loans.

Homebuilders know exactly how that hit feels. David Seiders, chief economist of the National Association of Home Builders, said Tuesday that the housing downturn is likely to be the “deepest downswing, the most rapid downswing, probably since the Great Depression.”

Seiders projects that the market — measured by home sales and housing construction — will hit bottom by the end of the summer and rebound gradually. But he emphasized that any recovery could be pushed back should predictions of recession come true.

In the commercial real estate market, investors have shied away from all but the safest loans. Credit rating agency Moody’s Investors Service said last month the performance of commercial mortgage-backed securities could be challenged this year by a weakening economy and uneasy financial markets. Tighter lending could cause commercial real estate prices to drop between 12 percent and 17 percent, Moody’s said.

Prices and demand for office buildings, malls and warehouses are falling with no signs of stopping soon, according to a report released last month by real-estate research firm Real Capital Analytics.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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