Commercial Loans Rise on the Books of Failed Banks

The profile of a typical bank failure has taken on a new shape in 2012, with the combustion of construction loan portfolios giving way to business loan blowups.

Over half of the roughly $14 billion of loans at banks that went belly-up in 2008, when the current wave of seizures began in earnest, were construction loans. Of the $2.4 billion of loans held by banks that failed this year through March 23, about 23% were commercial and industrial loans, well above this category’s 16% share for all banks with less than $10 billion of assets at Dec. 31.

The transition makes sense. Loans backed by unfinished developments unraveled quickly in the recession, and sank heavily exposed banks just as fast.

Construction loan portfolios remain distressed, and continue to push banks over the brink. Across the industry, such loans had by far the worst nonperformance ratio of any major loan category at over 13% at yearend, and accounted for the largest pool of repossessed assets at almost $15 billion. Moreover, the burden is concentrated among smaller banks, which have devoted a disproportionate amount of their balance sheets to construction lending. (Data considered here excludes thrifts.)

But big lumps have been taken, and commercial real estate loans overtook construction loans as the biggest piece of the pie at failed banks in 2010.

The significant representation of commercial and industrial loans this year largely reflects the demise of the $1 billion-asset Tennessee Commerce Bank, the former bank unit of Tennessee Commerce Bancorp in Franklin, as failures overall have tapered.

The single-branch bank focused on lending to middle-market businesses. Republic Bancorp (RBCAA) in Louisville, Ky., which acquired most of Tennessee Commerce’s deposits but left most of its loans with the Federal Deposit Insurance Corp., said the bank had followed an “aggressive lending strategy” and relied on high-cost deposits raised over the Internet or through brokers.

Tennessee Commerce had classified 35% of its business loans under categories requiring special management attention or indicating more serious weaknesses as of the second quarter before reporting that a regulatory review would force it to restate results for the period. In mid-January, shortly before it was seized, the bank said it had turned up even more problems in its small-ticket specialized equipment portfolio.

Commercial lending has been at the center of notable meltdowns in the past: Advanta Bank, a unit of the collapsed small-business credit card issuer Advanta, was seized in early 2010, for instance. But the decline in the pace of failures arising from other sorts of credit issues is allowing problems in C&I portfolios take up more of the spotlight.