Lenders' tightened credit requirements for construction loans, spurred partly by heightened regulatory scrutiny, are keeping viable commercial projects from getting off the ground, some finance and development market observers here say.

Kate McCaslin, president and CEO of the Inland Pacific Chapter of Associated Builders & Contractors Inc., says the only commercial construction projects launched in the private sector lately have been self-financed. Most companies, though, don't have the financial resources to finance their projects, McCaslin says.

"Even if they have the capital, they aren't going to put it down and tie up their businesses," she says.

McCaslin says the U.S. Treasury Department tried to pump money into financial institutions to encourage them to increase lending, but that hasn't helped the commercial construction industry.

"The Treasury Department advocated for lending," she says. "Bank regulators came in right behind and said they don't want to see these (construction) loans on the books."

Randall L. Fewel, president and CEO of Spokane-based Inland Northwest Bank, says he shares that frustration.

"We're getting mixed signals from the government," Fewel says. "There's a major disconnect between what Washington, D.C., says and what regulators on the ground are saying."

Bank regulators are encouraging banks in the Pacific Northwest to reduce lending on non-owner-occupied commercial real estate, he says.

Due to that pressure, "We're not really making loans to developers," he says. "Even if someone who wanted to develop a strip mall came to me with three fourths of it preleased, I still wouldn't be interested."

Fewel says there is some merit to such regulatory pressure.

"Ithink you would find a correlation between loan problems andnon-owner-occupied commercial real estate loans," he says. "Washington state has one of the highest ratios of non-owner-occupied commercial loans to capital in the country."

Banks now are focusing on making small-business and owner-occupied commercial loans, Fewel says.

Regulators have swung the pendulum too far, though, and are encouraging banks to increase balance-sheet liquidity by converting certain loans to bonds or other liquid assets, Fewel says.

"Banks aren't in business to buy bonds," he says. "They are in business to make loans. Credit fuels the economy. Bonds are much lower yielding and do nothing for the local economy."

Contrary to what regulators seem to be saying, an important component of economic recovery is the ability to make good loans, Fewel says.

"Construction and development create jobs," he says. "To me, that's grass-roots America."

The unfinished foundation for the long-stalled Best Western Peppertree Inn project at the northwest corner of Third Avenue and Division Street is a highly visible example of the results of a shift to stricter lending policies, says Rita Santillanes, who is codeveloping that project with her husband, John. Work on that planned 115-room hotel and connected parking structure halted more than a year ago, because the Santillaneses' lender had pulled out of the project, and they've been searching for another lender since then.

The Santillaneses also own Best Western Peppertree Inns at the Spokane International Airport, and in Liberty Lake, Omak, and Auburn, Wash., all of which they developed.

Lenders required the Santillanes to put up 20 percent to 25 percent of the capital to qualify for construction of their previous hotel projects, Santillanes says. Now, the same lenders require them to put up 40 percent to 50 percent of the capital needed for construction, she says.

Santillanes says the couple wouldn't be able to commit that much capital and still have enough cash to operate their current hotels.

"Because hospitality facilities are seasonal, we have good months and bad months," she says. "In good months we have to save cash on hand to pay bills during the bad months."

The Northwest Business Development Association has made commitments for $4 million in U.S. Small Business Administration-backed loans to the Peppertree project here. The NWBDA is a Spokane Valley-based nonprofit that handles loans under SBA's Section 504 job-retention program. Such loans only can be used to buy or improve land or buildings or to acquire long-term equipment.

While that loan commitment eventually should reduce the commercial lenders' risk on the project, a 504 loan can only be used for long-term financing after construction is completed, Santillanes says. The Santillaneses still need to arrange a short-term commercial construction loan to restart the project.

Two years ago, the same bank that provided the construction loan for the Peppertree hotel in Omak converted that loan into a permanent loan once the project was done, Santillanes says.

"That's also how we financed it in Auburn," she adds.

Meantime, the Santillaneses continue to pursue commercial lenders.

"Nothing is firm, but a bank in Oregon is showing interest," she says.

Gilbert Acevedo, NWBDA's president, says the association usually makes its loan commitments after a commercial lender is on board with the project. In the Peppertree case, a lender wanted NWBDA's commitment first as a show of confidence, he says.

NWBDA issued 28 loans totaling $18.7 million in fiscal 2009, down from 41 loans totaling $22.9 million a year earlier. The association's loan volume dropped steeply early last year, but picked up some later due to incentives in the American Recovery and Reinvestment Act, Acevedo says. The stimulus incentives include a waiver of 504 loan fees that amount to about 2 percent of each loan.

NWBDA's 2009 volume was 40 percent below the 2007 peak of $31.5 million, but still higher than any year before then.