Many bankers have complained that valuing real estate has become more of a guessing game these days, but few have gone so far as Hugh Potts Jr., the chairman and chief executive officer of First M&F Corp. in Kosciusko, Miss.

This week the $1.7 billion-asset First M&F surprised analysts by posting a wider-than-expected loss of $10.2 million, or $1.14 a share. Potts said erring on the side of caution put the company in the red; it hiked its provision for loan losses 2,400% from a year earlier, to $19.8 million.

Though credit quality worsened significantly during the quarter, most of the increase went to build its reserve. Potts cited the need for a bigger cushion not only because of the deteriorating economy, but because he is flummoxed about property values.

"When you are talking about a house, you don't know what it is worth until you sell it," he said in an interview. "That reserve is going to be tapped as we liquidate some of the nonperforming assets. Not until then can we realize the adequacy, excess or deficiency of that reserve."

Daniel Cardenas, an analyst at Howe Barnes Hoefer & Arnett Inc. in Chicago, said First M&F's reserve is more than double the median for banking companies of similar size in its region.

"Lots of companies are building it up, but not as aggressively as that," said Cardenas, who does not cover First M&F.

James Schutz, an analyst at Sterne, Agee & Leach Inc., said First M&F's decision, though surprising, is a good idea, given its exposure to residential real estate.

"It is certainly unusual for a bank to build up its reserves to the extent that it has," Schutz said. "It was a very aggressive build, and I would be surprised if they increased it further."

First M&F — which also has created a department to handle problem credits — fattened its allowance for loan losses by 147 basis points from a quarter earlier and 242 basis points from a year earlier, to 3.59% of total loans at March 31.

About a third of its assets are construction and development loans or mortgages. These categories are the primary drivers of the company's problems.

In the first quarter nonperforming assets doubled from the fourth quarter, to $62.3 million, or 3.8% of total assets. Chargeoffs totaled $3.5 million, or 1.13% of average loans.

Potts said the sharp deterioration reflects the housing markets in Memphis and Birmingham, Ala., which have been relative latecomers to the economic downturn.

The company also has a small exposure to the Florida Panhandle, one of the first areas in the country to experience the downturn in residential real estate values.

First M&F entered those states in 2006 by buying the $191 million-asset Columbiana Bancshares of Columbiana, Ala., and Crockett County Bancshares in Bells, Tenn.

Schutz said those purchases signaled a shift for First M&F. "They used to be a small sleepy bank, but they got a bit aggressive in expanding into very high-growth areas. Clearly, times have changed."

On average, analysts had expected First M&F to report a first-quarter loss of only 2 cents a share, according to Thomson Reuters.

In the first quarter of last year the company earned $3.1 million, or 34 cents a share.

Brian Klock, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc., wrote in a research note that the "outsized" provision equaled 6.76% of loans.

According to Klock, the first-quarter loss shaved First M&F's tangible common equity ratio by 80 basis points from yearend, to 5.4% — a figure that he considers low. As a result, he wrote, the company is likely to cut its quarterly dividend, currently 13 cents a share.

Potts said that his company is simply recognizing how much worse things could get, and that it is choosing to take its lumps now, rather than having to build the reserve continuously.

"This is more of an issue of time than substance," he said. "All the banks are going to end up in the same place sooner or later."

However, at least part of the increase can be attributed to the fact that new people are examining old credits. Over the last six months First M&F went through a reorganization, a large part of it involving its credit functions. The company created a department to handle problem assets, and it hired a new chief credit officer, an additional appraisal officer and a new loan review officer.

First M&F also created the position of chief banking officer to foster the centralization of its processes.

Potts said that the reorganization is partly a succession planning effort (Scott Wiggers, the company's vice chairman and president, is set to retire at yearend), partly a reaction to the economic environment and partly a result of normal business changes.

Schutz said that even though he was unsure about what prompted the changes in credit oversight, it makes sense for First M&F to bring in new people to help get through the problem credits.

"Very often when things go sour like this, you just want a clean house," he said. "You want new blood to take a good hard look at the portfolio."

Deposit growth was a bright spot in the first-quarter results, according to Schutz. Though deposits were flat from a year earlier, they increased $50 million from a quarter earlier, to $1.31 billion on March 31.

Potts said that $10 million of that growth stemmed from the $30 million capital infusion his company received through the Treasury Department's Troubled Asset Relief Program. He said the parent company is holding the money as cash on deposit at the bank unit to use for general corporate purposes. He would not be more specific.

However, Potts also said the company has been giving incentives to employees to drum up business. In addition, it has started offering a checking account that pays a high interest rate for customers who are willing to conduct more Internet banking, use their debit cards more often and give up paper statements.

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