Standards on AD&C Loans Ease, Interest Rates Expected to Rise

Builders and developers responding to NAHB’s AD&C Financing Survey continue to report easing credit conditions for acquisition, development, and single-family construction loans, over the first quarter of 2018, but the pace of easing slowed. At the same time, the majority of survey respondents indicated that the typical loan they obtained in the first quarter of 2018 was tied to a benchmark rate, usually the prime rate. Trends in the prime rate are closely tied to the federal funds rate indicating that, in addition to mortgage rates, anticipated policy tightening will also raise rates on supply-side loans as well.

Lending standards on AD&C loans eased over the first quarter of 2018. The figure above indicates that all major categories of AD&C financing also recorded net easing, with a larger net proportion of survey respondents indicating that standards had eased on single-family construction or land development loans. However, the pace of easing slowed from the previous quarter and from one year ago. The extent of easing overall in the first quarter of 2018 was less than the estimate of easing both one quarter ago and one year ago. Negative readings indicate net easing while positive ones signal net tightening. The figure above also illustrates that the slowdown in easing overall reflected a deceleration on the availability of loans across all stages of residential production.

Typically, lending standards refer to non-interest rate loan characteristics. In addition to loan availability, survey respondents were also asked to comment on interest rates associated AD&C loans. Previous analysis has indicated that interest rates have been rising. The figure above illustrates that the median interest rate on a typical loan for land acquisition, land development, and single-family construction during the first quarter of 2018.

Interest rates on land development and speculative single-family construction loans exceeded rates on land acquisition and pre-sold single-family construction loans. However, this is the first quarter of data and the differences across loan types may not be statistically significant. Alternatively, the differences may reflect the timing of origination within the three months of the quarter.

The majority of survey respondents indicated that a typical acquisition, development, or construction loan (whether speculatively built or pre-sold) they obtained over the first quarter, was tied to a benchmark rate, typically the prime rate. Across each loan type, 60 percent or more of respondents indicated that the typical loan they obtained in the first quarter was tied to the prime rate. Survey results indicated that the median spread between the loan rate and the benchmark rate was the same across all four loan categories, one percent.

The figure above indicates that the prime rate tracks the federal funds rate closely. The Federal Reserve is widely expected to raise the policy rate at its June meeting. Both the Federal Reserve and financial markets have signaled additional rate increases this year and in 2019. Previous analysis has documented the role played by monetary policy in the recent cycle increase in mortgage rates. Tighter monetary policy will also raise rates on loans for housing production. To a lesser degree, however, the full extent of an increase in loan rates may also be determined by the risk premium associated with lending.

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