For only the second time since the financial crisis, banks increased net construction lending during the third quarter. Construction loans held on balance sheet inched up $3.6 billion, of which $1.1 was for single-family and small residential properties; $2.5 billion, for multifamily and broadly-defined non-residential development.

Banks' legacy exposure to construction lending has improved significantly over the last several quarters. From a peak default rate of nearly 17 percent in early 2010, the percentage of construction loans 90 days or more delinquent or in non-accrual status has fallen to 4.9 percent, half its year-ago level. Construction loans in REO have been halved, as well. Not everything is improving. The recidivism rate of construction troubled debt restructuring is still 47 percent.

Construction lending has been concentrated in the multifamily sector until recently, with banks underpresented as sources of capital in that market segment. As new opportunities have emerged for lending on core and mixed use development, construction financing has reasserted in primary and some secondary markets. In Tier 1 markets like New York, transformative projects are already underway with support from a wide range of lenders and REITs' access to public markets. The largest banks may compete for these loans individually or through syndication, but the primary beneficiaries of new regional and community bank lending (and credit unions, as well) are relatively smaller borrowers.

On balance, underwriting on construction loans remains conservative. On the margins, however, some banks are making riskier loans as competition for stabilizied property financing increases. Short-term lending is adjusting slowly to the threat of more costly permanent financing. Construction costs are rising, as well; loan-to-cost trends understate lending per square foot, unit, and key. Among active community banks, in particular, concentrations in commercial property and construction lending are on the rise again.