Small Builders Feeling the Squeeze by Credit and Sub-Prime Crisis

First homeowners lost their properties to foreclosures due to the sub-prime debacle. Now, many US small n and mid-size home builders are feeling the pain and are facing losing their businesses.  
 
Bill Whitlatch, long-time owner of one of the leading home builders here in northeast Ohio, is among the casualties. Three years ago, he borrowed from regional banks to start six developments in the Cleveland area. Soon the region's home market turned cold. Buyers vanished. Mr. Whitlatch drained his personal savings of $2 million to keep his company going.  
 
It wasn't enough. In September, the company filed for bankruptcy protection. Now owing about $1 million to dozens of subcontractors, and $8 million in debt to his banks, Mr. Whitlatch is selling the family home he designed.  
 
Though he and other local builders didn't know it at the time, Cleveland's housing slump was one of the first manifestations of a national slowdown. Now, plummeting home sales across the U.S. have left many builders with unsold inventory and land. Some are falling behind on interest payments, beginning to face foreclosures on developments and, like Mr. Whitlatch, sometimes reaching into their own pocket to keep operations going. Many smaller builders financed their developments with so-called recourse debt, which means that if they default, banks could seize homes, cars and other personal assets.  
 
The U.S. government is now scrambling to contain the damage from the housing market's unraveling. On Wednesday, federal regulators cleared the way for mortgage-finance giants Fannie Mae and Freddie Mac to inject as much as $200 billion into the mortgage market, a credit-boosting move that could help builders' flagging sales. Yet for people like Whitaltch it's too late.  
 
"There are a lot of companies on the brink" of bankruptcy, says Ricardo Chance, a managing director at KPMG Corporate Finance LLC, who is helping troubled builders in the Midwest, Northeast and Arizona restructure their businesses.  
 
Builders' problems are now threatening losses for small and medium-size regional banks. Muscled out of the mortgage business by large national lenders, many of these banks flocked to construction lending as the housing market boomed. Though these institutions were generally less exposed to the sub-prime-backed securities that have generated billions of dollars in losses for national banks, they are the front-line casualties when builders and developers can't make their payments.  
 
Delinquencies on loans to build single-family houses reached 7.5% of the value of all such loans in the fourth quarter, up from 2.1% a year earlier, according to Foresight Analytics, an economic and real-estate research firm. There's likely more pain ahead. The Commerce Department reported this week that permits for new housing construction, a barometer of future building activity, fell 7.8% in February to the lowest level in 16 years. Also this week, the Federal Deposit Insurance Corp. said it had "increased [its] overall concern" about banks with high concentrations of construction loans, particularly those for residential developments, its strongest warning to date about these banks.  
 
Federal Reserve Chairman Ben Bernanke warned Congress late last month that he expected some small U.S. banks to fail due to the housing stress. Analysts say as many as 150 banks could fail over the next three years. By comparison, about 900 banks and savings-and-loans associations failed from 1990 to 1995, according to the FDIC.  
 
This credit crunch is not perceived to be as bad as the S&L crisis," says Ivy Zelman, chief executive of Zelman & Associates, a housing research firm. But depending on how regulators respond, she says, "I think it could be."  
 
Analysts worry that losses from home-construct