A term from the days of the savings and loan crisis is creeping back into the industry lexicon — performing nonperforming loans.
Bankers and analysts are using the term to refer to loans where payments are still being made on time, though changes in market conditions indicate potential trouble ahead.
Performing nonperformers have become an issue lately as regulators take a tougher stance on whether these loans require reserves to be set aside now.
Regulators don't use the term, but stress that they are prodding banks to be more proactive in socking away reserves.
Bankers and analysts say there has always been a gray area for judgment calls, and the disappearing leeway might be one reason an old term like "performing nonperforming" is in use again. Some loans that technically might qualify as performing from the bank's perspective are being flagged for their weakness and accounted for as nonperforming.
Another factor is the rapid decline of property values in some markets. With the collateral on many loans, particularly construction and development ones, having a lower value, bankers are struggling to assess their risk.
Gerard Cassidy, an analyst with Royal Bank of Canada's RBC Capital Markets Corp., said the increased regulatory scrutiny of performing nonperformers took the $6.8 billion-asset Boston Private Financial Holdings Inc. by surprise last quarter.
Boston Private was late filing its fourth-quarter earnings, at least partly because it needed more time to calculate loan-loss reserves for construction and development loans where payments had not lapsed.
It warned in February that it would report a fourth-quarter loss higher than the previously announced $20.4 million, because of a significant increase in its loan-loss provision. It said weakness in the residential construction and land loan portfolio at its Los Angeles unit — a problem that became apparent during a Federal Deposit Insurance Corp. exam — required the company to add at least $16 million to its provision for the quarter.
Mr. Cassidy said the troublesome project loans at Boston Private's First Private Bank and Trust had interest reserves that ensure payments are made during construction.
"What happened at Boston Private — and we're now hearing it from other banks as they report first-quarter results — is that they were under the impression that their construction loan portfolio was fine, because the developers were paying on time. But clearly that was the case because the developers were using their interest reserves," he said.
In Boston Private's case, he said, "the regulators came in and said, 'It's true. The loans are current, but we don't believe the collateral value is sufficient to carry the loans. Therefore, write them down.' "
Boston Private would not discuss the matter. But in the Feb. 20 press release announcing that it had to revise earnings, Timothy L. Vaill, its chairman and chief executive, said: "We continue to walk the line between real and perceived credit troubles. Although we've not incurred any material losses to date on these loans, we are increasing our reserves to prepare for any such eventuality."
Over the past few months an unusually high number of banking companies have said they had to delay filing their fourth-quarter and full-year results. Some cited the need for more time to evaluate their loans and calculate their reserves.
Among the industry's publicly traded companies, 34 notified the Securities and Exchange Commission that they would be unable to finalize their 10-Ks on time — 10 more than were late with their 2006 results.
In contrast, a study by Glass Lewis & Co. found that late filings for midsize companies across all industries fell to their lowest level in four years.
Considering the significance bankers put on avoiding late filings, several analysts said they consider the increase notable. They attribute it to regulatory scrutiny and more conservative accounting, combined with difficult market conditions that make calculating reserves and valuing securities a challenge.
Mark Fitzgibbon, the head of research at Sandler O'Neill & Partners LP, said that the FDIC in particular has "stepped up" examinations and is "becoming much more involved in encouraging banks to write things down."
Steve Fritts, the FDIC's associate director for risk management policy, said it is urging bankers to be mindful of the challenging housing industry, to monitor construction and development loans, and to maintain strong reserves. He said it emphasized those points in a March 17 industry letter.
No one factor — whether interest reserves or collateral value — is enough to indicate whether a loan requires a provision or should be categorized as nonperforming, Mr. Fritts said.
Robust loan administration entails checking on construction activity, the borrower's finances, and whether projected sales are being met, he said. "The interest reserve is a fairly common and perfectly acceptable methodology, but we do expect lenders not to be lulled to sleep by the fact that they have interest reserves."
Other agencies are also stressing that bankers need to become more proactive about recognizing when a loan is in trouble.
In a speech last week, Comptroller of the Currency John C. Dugan said community bankers in particular are in denial. "Right now too many community bankers are having too hard a time coming to grips with the problems that have emerged in their commercial real estate portfolios. These bankers are reluctant to charge off obviously troubled loans or even to flag problems to their examiners."
Still, Mr. Fritts said regulators label loans as either performing or nonperforming and shun the use of phrases like "performing nonperforming" as imprecise and confusing. "It has no technical meaning for us. I'm reluctant to give it any currency."
Chip MacDonald, a partner in the capital markets group at the law firm Jones Day, said the term, which he first heard in the early 1990s, is coming around again because such loans are a big problem these days in formerly hot markets like California and Atlanta.
"They're classified assets that are still performing but are potential problem loans in FDIC lingo," Mr. MacDonald said. "Banks are writing them down pretty dramatically."
Dennis Hild, an executive in Crowe Chizek & Co. LLC's financial institutions group and a former regulator, said he is unfamiliar with the expression.
"Everyone is getting tied up on this terminology," he said. "But I think what regulators are saying is, 'You've got some stress here in this credit. … We need to take a loss now, because we're never going to get this back.' "
Capital Corp. of the West lost $14.2 million in the fourth quarter, primarily because its deteriorating credit quality required a $25.2 million loan-loss provision. The Merced, Calif., company belatedly filed the earnings report with the Securities and Exchange Commission this month.
Thomas T. Hawker, the president and CEO of the $2.1 billion-asset Capital Corp., said it needed the extra time to finalize the earnings because property values in California's Central Valley had declined dramatically from the third quarter, requiring new appraisals for much of the loan portfolio.
"You see an appraisal for land in a given area in September at X, and in January it's X divided by two," he said. "As real estate values go down, your loan advance relative to the collateral changes, so a loan that might have been at 70% of the collateral value now might be at 150% or 200% of the collateral value."
Some of the loans that fueled the higher provision are not behind on payments, Mr. Hawker said, but because property values fell — and thus the collateral was no longer worth as much — the loans had to be classified as substandard. "So even though it might be paying, we can't show it as a performing asset."
He said he had never heard of performing nonperforming loans until Capital Corp. ran into trouble. "That's a new term that has slipped into the vocabulary, and it's very appropriate. I don't remember ever using it before, but it's certainly one that I'm hearing now."
Mr. Hawker — who is 65 and plans to retire once a successor is hired — said regulators did not prompt the appraisals, but they got involved after Capital Corp. sent up the initial red flag.
He said his company anticipates a written enforcement order because of the trouble, which caused its County Bank to dip briefly below well-capitalized status.
Last month Capital Corp. announced that it had hired KBW Inc.'s Keefe, Bruyette & Woods Inc. to help it raise capital and evaluate other strategic alternatives.
