New Worries for Small Banks

By FLOYD NORRIS

Published: August 31, 2007

For America’s small banks, the changing financial landscape of the last decade meant that many opportunities were no longer available. The big national banks went after consumer lending and came to dominate the market for credit cards. Lending to big companies had long since migrated away from local banks.

What was left? Real estate. That included home mortgages, of course, but in that business there was more and more competition from independent mortgage brokers and from national companies that packaged the loans and sold them to investors. The banks’ share of such mortgage lending was still large, but it was declining.

Still, one part of the real estate picture remained dominated by local financial institutions: lending to local land developers. It was a market where local knowledge mattered.

A result has been a steady increase in commercial real estate loans, particularly loans secured by raw land that a developer plans to build on.

By the middle of this year, 15 percent of the assets of smaller financial institutions in the United States — defined as those with less than $1 billion in assets — were in construction loans, quadruple the proportion a few years ago.

Now, the banks that were most dependent on that strategy are being questioned by investors — in some cases to the irritation of bank executives who say they are being tarred by fallout from lending excesses in which they had no part.

“Everything about Colonial is speculation, and rumor and fear,” Robert E. Lowder, the chief executive of Colonial BancGroup, a bank holding company based in Montgomery, Ala., complained in a conference call this week.

Of Colonial’s $15.5 billion in loans, 42 percent are construction loans. Most are in Florida, where the real estate boom has faltered.

“Everybody’s down on Florida,” Mr. Lowder said. “Everybody thinks Florida is going to fall into the Gulf of Mexico. Trust me, Florida is still a great place to be.”

The chief executive of another bank heavy in construction loans, the Las Vegas-based Community Bancorp, was in New York this week assuring institutional investors that they should not worry. “We’re doing great,” the executive, Edward M. Jamison, said in an interview. “We see a lot of vitality in our markets.”

With home prices falling and mortgage delinquencies rising in many areas, banks now feel a need to prove their loans are safe. Mr. Jamison emphasized that his bank lent to commercial, not residential developments, principally strip malls. Mr. Lowder, whose bank does finance residential developments, said it had avoided speculative projects.

Few construction loans are behind in interest payments, but that fact may be less reassuring than it seems, since many such loans do not require payments until the project is completed.

Bank regulators are at least a little worried. The Federal Deposit Insurance Corporation keeps track of banks that are heavily dependent upon commercial real estate loans — either because construction loans are greater than the capital of the bank or because total commercial real estate loans, including mortgages on commercial properties, are at least three times the bank’s capital. By this June, 37 percent of all banks met one or both criteria, triple the figure of a decade ago.

Early last year, the regulators proposed new rules on such loans, but the watered-down policy that finally came out did little more than to warn that “rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the advent of adverse changes in commercial real estate markets.”

In the stock market, banks with such concentrations have done a little worse than other banks this year. Short-interest on those stocks is up sharply, a sign that hedge funds think banks will end up owning a lot of vacant real estate, having to pay taxes on land that brings in no income.

Mr. Jamison, the Las Vegas banker, scoffs at such a forecast.

“It would,” he told me, “be almost a perfect storm to have a meltdown in the real estate market.”