In 2007, Peter Kloeckner, a business loan manager at Southeast Bank of Texas, was considering approving a $38.375 million loan to Crawford Development Co. (CDC) for a development opportunity in Houston, Texas. CDC, led by Andy Crawford, was known for successful real estate projects and was considering a 50-acre parcel of land, the Huntley Farm, for development. The land offered flexibility for either an office park or a residential neighborhood.
The Houston real estate market seemed promising, especially for office development, with strong economic indicators and rising demand for office space from oil and gas companies. However, the residential market faced a credit crunch and falling housing prices due to the subprime mortgage crisis. Still, the Houston market showed more resilience compared to other regions.
Kloeckner was concerned about the potential risk and profitability of CDC's options. The office development seemed stable, but the residential project held higher upside potential if the market performed well. CDC had the required equity capital, and the bank's analysts suggested approving the loan at a competitive 7% interest rate for a three-year term.
Main Business Problem:
The main business problem in the case is to assess the risk and potential profitability of Crawford Development Co.'s two options: an office park or a residential neighborhood development. Choosing the less profitable option could result in substantial losses for Southeast Bank of Texas. The residential option presented higher risk due to the troubled real estate market, while the office option seemed more stable but with limited growth potential.
Variables to Address in Each Development Option:
Office Park Development:
Office park sales can be forecasted based on 31 observations of historical data that have correlation with historical market outcomes.
Provided anticipated market outcomes:
37.5% Chance of Unfavorable Markets in the Future
28.125% Chance of Neutral Market Outcomes
34.375% Chance of Positive Market Outcomes
Construction costs for the office park will be guaranteed at 20 M.
Southeast Bank of Texas is willing to offer an interest rate of 7%.
Residential Neighborhood Development:
Sales are expected to be $130 M at best, $42.3 M at break-even, and $20 M in the worst makert case scenario.
Construction costs for the residential project are expected to be $20 M, but will vary with a standard deviation of $1 M.
Southeast Bank of Texas is considering offering interest rates that range from 7-11%. For every percentage point increase in the interest rate offer, there is a 25 percentage point increase that Crawford Development Company rejects the loan:
7%: 100% Probability CDC accepts the loan
8%: 75% Probability CDC accepts the loan
9%: 50% Probability CDC accepts the loan
10%: 25% Probability CDC accpets the loan
11%: 0% Probability CDC accepts the loan
Business Impact of Selecting the Correct Project:
Choosing the correct project was critical for both Crawford Development Co. and Southeast Bank of Texas. If the bank approved the riskier residential project, CDC could struggle to break even or generate enough sales to repay the loan, leading to potential losses for the bank. However, if the office project was selected, while it offered stable returns, the bank might miss out on the higher potential profits from the residential option.
Given the large loan amount involved ($38.375 million), Crawford could stand to lose millions of dollars if the risk was not properly assessed, and the less profitable option was chosen. Southeast Bank of Texas could also face significant financial losses if CDC's project failed to perform as expected.
The decision would require a thorough technical analysis in R, considering various economic indicators, historical and projected sales, construction costs, and market projections to make an informed choice that aligns the interests of Crawford Development Co. and the bank. Both parties needed to carefully weigh the risks and rewards before proceeding with the loan and development.
Analysis and Results
Please see the attached PowerPoint presentation for the detailed analysis, simulation results, and recommendations for both parties.
Additionally, the attached R file contains all simulations and programming used in the project.