Marshall & Ilsley Corp. said its credit costs were higher than expected in the third quarter thanks to bad loans to other lenders, a segment experts say could be increasingly problematic for some big banks.

The Milwaukee company caught analysts and investors off guard Tuesday with news that provisions and chargeoffs were substantially higher than projected after writing off $160 million of credit to four banking companies in the Midwest and other regions.

Gregory Smith, M&I's senior vice president and chief financial officer, said the four lenders — which he would not name — were the "most challenged" borrowers in M&I's $545 million portfolio of loans to bank holding companies. Though 75% of those credits were current at the end of last month, he said, M&I felt it best to cut its losses given the depth of those borrowers' problems, including mounting loan losses and trouble raising capital. Some of the companies in its bank holding company portfolio have been subject to regulatory actions, he said.

"The right thing to do was to take aggressive steps as it relates to these few loans," Smith said.

"We took these to zero."

Smith would not discuss the prospect of further chargeoffs in M&I's bank loan portfolio, a small sliver of its $48 billion in loans and leases. But he said the company has "positioned itself well" after setting aside $90 million of reserves and $185 million of provisions to cover further bank holding company loan losses.

Analysts said losses in bank-to-bank lending could be an issue for other institutions as the recession drags on and more banks fail.

"Marshall & Ilsley is not going to be the only one who is dealing with this issue," said Jeff Davis, an analyst at First Horizon National Corp.'s FTN Equity Capital Markets.

"The small banks are under stress — that is the bottom line. They don't have as easy access to the capital markets, like the larger banks who can do a bond issue or raise equity."

Gauging banks' exposure to other banks is difficult, as most companies don't disclose details about their bank-to-bank lending portfolios, usually classifying them under the banner of commercial and industrial loans.

Still, the wave of bank failures has forced some institutions to disclose their ties to troubled ones.

First Horizon National said last year that it had loaned less than $25 million to Vineyard National Bancorp of Corona, Calif., whose main banking unit failed in July; First Horizon said it had 64 other borrowers in its correspondent lending business.

Integra Bank Corp. of Evansville, Ind., reported that it charged off about $17 million tied to the parent of Peoples Community Bank in West Chester, Ohio, which regulators seized in July.

Marty Mosby, another FTN analyst, said most banks dabble in correspondent banking, but M&I does an unusual amount of business with other lenders for an institution its size.

The $60 billion-asset company became active extending senior debt and other types of loans to community and regional banks through its ownership of Metavante Corp., a financial services concern it sold in 2007, Mosby said. Metavante helps banks develop their technology platforms. M&I cross-sold its lending products to Metavante clients, Mosby said.

Despite the issues in the bank lending book, Smith said several things were looking up for M&I on the credit front.

Its level of nonperforming loans is expected to fall for the first time in four years by $170 million, as it is seeing improvements in early-stage delinquencies. Provisions excluding the capital set aside for the bank holding company books are in line with earlier projections.

Smith said Tuesday's announcement shows M&I is being "proactive" in moving past its problems by clearing its balance sheet of troubled loans.

M&I said it now expects to report third-quarter chargeoffs of $530 million to $540 million, after saying in August that it expected chargeoffs of less than $452.6 million.

Provisions in the quarter should be $575 million to $585 million, up from its earlier projection of less than $468.2 million.

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