The housing market's collapse has forced First National Bank of Georgia in Carrollton to change its approach to lending.
Residential construction lending has slowed to a trickle in recent months, so the $888 million-asset unit of WGNB Corp. is beefing up its commercial real estate lending on income-producing properties, and it is training bankers to make more commercial and industrial loans, said H.B. "Rocky" Lipham 3rd, the chief executive of the bank and its parent.
"We had always planned on leveraging the relationships of our real estate customers by offering them C&I loans, but we wouldn't have gone into it as quickly" had the housing boom not turned to bust, he said.
But make no mistake — Mr. Lipham is eager for the housing market to recover, so First National Bank can ramp up its residential construction lending again.
"With all the population growth around Atlanta, you've got to be crazy to want to get out of this business," he said.
There is no question that the housing downturn has hit community banks hard, particularly in what have been fast-growing regions, such as the Southeast, the Southwest, and the Pacific Northwest. Construction and development lending is one of the primary business lines at many community banks, and unlike large ones, they have neither a broad array of fallback businesses nor a large retail customer base to generate hefty fees.
Some small banks — mainly those that have posted huge losses in their construction portfolios — are weathering the downturn by hunkering down and scaling back lending. Others are following First National Bank's example by gunning for other types of commercial loans, though competition for those loans is fierce.
Most importantly, many banks are re-evaluating and strengthening their underwriting practices, as examiners increase scrutiny of banks with heavy concentrations of commercial real estate loans, particularly construction and development ones.
In a Jan. 31 speech to the Florida Bankers Association, Comptroller of the Currency John C. Dugan warned bankers in stressed markets that they may need higher loan-loss provisions and capital.
Regulators started warning community banks in fast-growing markets a few years ago to manage risk better in their commercial real estate and construction portfolios, but the general consensus among bankers was that underwriting practices were sound; many cited low levels of chargeoffs and nonperformers as evidence.
But things have changed in recent quarters. Countless projects have been put on hold in mid-construction, leaving many developers unable to repay their loans. As a result, many banks' nonperformers and chargeoffs are at their highest levels in years, and most experts expect them to keep rising this year.
Jefferson Harralson, an analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc., said average loss rates on construction loans for small-cap and midcap banks could near 2.25% of total construction loans this year, or roughly half the 4.74% rate on such loans recorded in 1991, in the thick of the savings and loan crisis.
"Residential construction lending has been a big piece of the growth at these banks, and credit quality is going to get worse in 2008," Mr. Harralson said. "A mild recession could raise those loss rates even higher."
One area hit particularly hard by the downturn is California's Inland Empire east of Los Angeles. The $4.4 billion-asset PFF Bancorp Inc. in Rancho Cucamonga reported a $14.7 million loss for its fiscal third quarter, which ended Dec. 31, because of a $35 million provision for losses, mainly from bad residential construction loans. Net chargeoffs rose to $56.6 million, or 5.61% of average loans, versus $83,000, or 0.01%, a year earlier.
Florida bankers also are struggling. At the $2.4 billion-asset Seacoast Banking Corp. of Florida in Stuart, fourth-quarter net income fell 67% from a year earlier, to $1.9 million, also because of bad residential construction loans. Nonperforming assets more than tripled, to $67.6 million, or 3.56% of total loans.
The good news is that most observers expect the majority of banks with high construction loan exposure, even those that have taken large loss provisions, to be able to ride out the storm.
Though the ratios of these loans on banks' books to their capital base are much higher than they were during the late 1980s and early 1990s, when many banks and thrifts failed, experts say most community banks still have enough capital and healthy enough earnings streams to absorb the losses.
James Abbott, an analyst at Friedman, Billings, Ramsey & Co. Inc., said that losses on CRE loans generally are spread out over several quarters, so most banks can offset them with ongoing earnings.
Take PFF. After analyzing the impact of likely credit losses on its balance sheet this year, another Friedman Billings analyst, David Rochester, projected that its tangible book value, currently $15.15 a share, will decline only modestly this year, to $13.51, because the company continues to post good margins and has been able to control expenses.
Likewise, Peyton Green, an analyst at First Horizon National Corp.'s First Midwest Securities Inc., said Seacoast should be able to rebound, because its total risk-based capital ratio is near 12%. However, it may have to raise additional capital if losses mount, he said.
Aaron Deer, an analyst at Sandler O'Neill & Partners LLP, said that many bankers are asking developers to deposit more cash into their reserve interest accounts, which are used to pay the interest on their loans during construction. (Developers usually repay the principal at the end of a project.)
In other cases, banks foreclose on the loans and try to recoup their money by selling the properties or holding them until the market improves, he said; another option is selling the problem loans altogether.
Mr. Harralson said regulators are asking banks to conduct more sophisticated feasibility studies on construction projects — something beyond obtaining 80% presale commitments, because potential buyers have been walking away from their down payments.
Several bankers whose institutions have been examined recently say regulators mainly want community banks with high CRE concentrations to demonstrate they have analyzed the risk in their portfolios thoroughly.
Cliff Painter, the chief lending officer at the $708 million-asset Four Oaks Fincorp Inc. in North Carolina, said it breaks down its CRE portfolio by loan type, borrower, geographic area, and residential subdivision.
"This tells examiners that our portfolio is actually spread out amongst many different contractors and subdivisions and is not concentrated in one particular area," Mr. Painter said.
Four Oaks then stress-tests each category to see how the bank could handle problems if the economy faltered. It then stress-tests the entire portfolio to analyze the overall risk.
Cynthia Blakenship, the chief operating officer at the $231 million-asset Bank of the West, a Grapevine, Tex., unit of Greater Southwest Bancshares Inc., said regulators have been pleased that her bank hired a third-party firm to review its loan portfolio objectively.
Responding to decreased demand for construction loans, banks are ramping up other business lines.
The $1.3 billion-asset Temecula Valley Bancorp in California is ramping up its Small Business Administration lending. Last year its SBA loans rose 39%, to $496 million, though construction lending still accounted for 47.4% of its portfolio at yearend. Fourth-quarter net income at the $8.3 billion-asset Umpqua Holdings Corp. in Portland, Ore., fell 61%, to $9.5 million, mainly because of a $17.8 million provision for loan losses in its residential construction portfolio. Until residential building picks up again in its Oregon, Washington, and Northern California markets, Umpqua intends to focus more on CRE lending for income-producing properties, as well as C&I lending.
Of course, Gary Stein, a partner with Capital Performance Group LLC in Washington, said competition for C&I and other commercial loans is already intense, and with fears of a recession looming, finding quality loans is difficult.
"There may not be as many deals, and there will be more competition for them, so margins will probably be compressed even further," he said.
But John J. Dickson, the CEO at the $4 billion-asset Frontier Financial Corp. in Everett, Wash., said other types of commercial loans may play a bigger part of banks' portfolios, since residential construction may not reach the same level as it had in the past few years, at least in most parts of the country.
"During this last cycle, there were homebuyers qualifying for mortgages on houses they really couldn't afford," Mr. Dickson said.
"I don't think C&D lending will get back to 2004 to 2006 levels — ever."
