Like many of the community banks they serve, bankers' banks have hit a rough patch.

Silverton Bank of Atlanta, the largest of the nation's nearly two-dozen bankers' banks, posted record profits last year after it beefed up its lending and aggressively expanded into new markets. But it is headed for a loss in 2009, because roughly $183 million of loans it either shares with or has bought from community banks are not performing.

It is a similar story at Nexity Financial Corp., the nation's only publicly traded correspondent banking company. The $1 billion-asset Nexity swung to a $3.8 million loss in the third quarter, from a profit of $1.4 million a year earlier, as delinquencies on loans it acquired from other banks in the Southeast soared. At Sept. 30 its ratio of nonperforming assets to total assets topped 7.6%, up from 0.71% a year earlier.

The struggles of Silverton (which changed its name from The Bankers Bank this year) and Nexity, based in Birmingham, show that bankers' banks and correspondent banks are not immune from the industry's problems, and in some respects are even worse off than their bank customers. That is because most of their participation loans are heavily concentrated in construction and commercial real estate, and delinquencies and defaults on those loans have soared as the economy has sputtered.

"There was an old saying," said Camden Fine, a former bankers' bank president and now the president of the Independent Community Bankers of America. "When the banks catch a cold the bankers' banks get the flu. Right now banks have a cold, so flu season is coming for bankers' banks."

Problems at bankers' banks go beyond their loan portfolios. Their business of making loans to bank holding companies — sizzling earlier this year as small banks' access to the capital markets dried up — has ground to a halt as banks instead weigh direct investments from the Treasury's Troubled Asset Relief Program. And a recent policy decision by the Federal Reserve Board has posed threats to the federal funds programs, which account for a large chunk of bankers' banks' income.

To be sure, marketplace turmoil has created opportunities for bankers' banks.

The $190 million-asset Community Bankers' Bank in Midlothian, Va., has doubled its number of bank customers since this time last year, in large part because regional banks have scaled back their correspondent services. And despite its asset-quality issues, Silverton has added 115 new customers this year.

But even the Virginia bankers' bank is starting to show some cracks. In the quarter that ended June 30, 1.13% of its loans were delinquent, according to Federal Deposit Insurance Corp. data, up from zero a year earlier.

Bill McFaddin, Community Bankers Bank's president and CEO, said that real estate conditions in markets his bank serves — Virginia, Maryland, and the Carolinas — have held up relatively well, and that the uptick in problem loans is "manageable."

But, he said, "Obviously the real estate market can deteriorate further and there will be increased exposure here."

Silverton Bank has made a name for itself in recent years by expanding into markets throughout the country already served by other bankers' banks, creating never-before-seen competition for community banks' business.

Its loan problems, though, are concentrated in Georgia, Florida, and Alabama, three of the states hardest hit by the real estate downturn.

"Nobody has ever gone through anything like this in any kind of bank before. It's a 75-year event," Tom Bryan, Silverton's president and CEO, said in an interview this week.

FDIC call reports show the company lost $5.1 million in the third quarter, following a $4.5 million loss in the second quarter.

Silverton raised $70 million of fresh capital earlier this year and remains well capitalized by regulatory standards. Mr. Bryan said the bank does not need to add any more capital, but it has nonetheless applied for almost $78 million through the Treasury Department's Troubled Asset Relief Program.

Karen Dorway, the president of BauerFinancial Inc. in Coral Gables, Fla., said that at the pace Silverton's delinquent loans are increasing — 37% between June 30 and Sept. 30 — it may need to raise more capital. By her firm's rating system, which that takes into account capital levels, profitability, delinquent loans, chargeoffs, reserves, and enforcement actions, she rates Silverton a "troubled" institution.

"Given the other challenges they are facing, they are certainly in a position where they would like to have more capital," Ms. Dorway said.

Independent Bankers' Bank of Florida in Lake Mary reported a $1 million third-quarter loss, citing an increase in its loan-loss provision and a $1.8 million writedown on its investment in Freddie Mac preferred stock.

Jim McKillop, Independent's president and CEO, said his bank set aside all of its quarterly earnings for losses because it expects more loans to go unpaid as real estate values continue to weaken.

Independent is considered very well capitalized, though it, too, is considering applying for Treasury money.

Having more capital than is required by regulators "is very important component in our management capacity … so our customers understand that we are unquestionably well capitalized and then together we can do a job that will help the economy," Mr. McKillop said.

Still, the availability of Treasury money is a bit of a mixed blessing for bankers' banks.

Many small banks that previously might have issued trust-preferred securities to raise money had been turning instead to their bankers' banks of late for loans as the trust-preferred market stalled.

But now banks have slowed their borrowing from the bankers' banks as they wait to see if they are eligible for investments from the Treasury at more favorable rates, said Steve Brown, the president and CEO of the $500 million-asset Pacific Coast Bankers' Bank in San Francisco.

"It's tough to do that business right now, because the music hasn't stopped," he said.

Bankers' banks are also facing competition from the Federal Reserve on overnight deposits they hold for community banks. Since October the Fed has been offering to pay banks 1% on their sterile reserves, or 75 basis points higher than what bankers banks' generally pay for Fed funds.

As the Fed pays "more interest on reserves it results in a reduction of what we have in our overnight Fed funds program," said L.D. McDonald, the president and CEO of the $407 million-asset Midwest Independent Bancshares Inc. in Jefferson City, Mo.

Mr. McDonald said the Fed funds program makes up as much as 15% of his bank's income.

Bankers' banks typically pool these funds and lend them out to other banks, and if banks park their money elsewhere, "it reduces our ability to serve some of our respondents, because we won't have the liquidity," Mr. McDonald said.

Fed Vice Chairman Donald Kohn said Wednesday that the central bank's strategy of paying interest on reserves is not causing banks to stop lending to one another.

"I don't have a suspicion that banks are lending to us and not lending to others," Mr. Kohn said after a speech at the Cato Institute. "We've had to interpose our balance sheet where private balance sheets would normally be."

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