Small and Midsize U.S. Banks Beginning to Struggle in Credit Crisis

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February 27, 2008
Small and Midsize U.S. Banks Beginning to Struggle in Credit Crisis
By ERIC DASH
The credit crisis is tightening the screws on thousands of small to midsize banks across the United States, squeezing local builders and businesses that depend on those lenders for financing.

Losses are mounting so rapidly at some of these banks that a small number of them, perhaps 50 out of the 7,500 nationwide, could fail over the next 12 to 18 months, analysts said. Some of the others are likely to shut branches or seek out mergers as the weakening economy strains their finances.

Small lenders are in far less danger than they were during the 1980s and early 1990s, when roughly 1,600 federally insured institutions failed during a savings and loan crisis. And unlike many bigger banks, they shied away from complex mortgage-linked investments and subprime home loans.

But the breadth and depth of the current troubles have caught bank executives by surprise.

Federal regulators are particularly concerned about the exposure of smaller banks to the commercial real estate market, which has begun to soften in some parts of the country.

“There were people in denial six to nine months ago,” said Keith D. Maio, the president of the National Bank of Arizona in Phoenix, a small bank owned by the Zions Bancorporation based in Salt Lake City. “I don’t know if anybody is in denial anymore.”

Federal regulators concerned about the health of the industry are stepping up regular bank examinations and forcing some lenders to bolster reserves. During the last four years, just four United States banks have failed.

Stock market investors see trouble brewing. Shares of small banks have tumbled in recent months, with the Standard & Poor’s midcap regional banking index sinking 20 percent from a year ago.

“The megabanks get all the headlines,” said Jaret Seiberg, a research analyst for the Stanford Group, a private wealth management and banking firm. “But this is causing a lot of trouble for the industry and it is going to persist for the next few years.”

Small banks have been losing business to larger rivals for years. Big banks have muscled them aside in the credit card and home mortgage businesses. In response, many small and midsize banks, typically defined as those with assets ranging from less than $1 billion and $20 billion, pushed into construction and commercial lending, betting that their local knowledge of markets would give them an edge.

The strategy paid off, delivering years of strong profit growth. But now, as real estate and construction loans sour, small lenders are starting to see their balance sheets pinched.

Mark T. Fitzgibbon, the director for research at Sandler O’Neil & Partners, said losses at smaller lenders might ultimately reach $105 billion, or 15 percent of what he projected could be $700 billion of losses industrywide.

“The real estate problem has gotten worse and more pervasive, more rapidly,” Mr. Fitzgibbon said. The rapid decline in home prices in areas like Florida and Southern California is just the start. “I think you will see that spread to other parts of the country soon,” he said.

Already, residential construction lending is running into trouble. As new homes have become harder to sell, developers are falling behind on payments, and are no longer seeking new loans.

For all public banks, the late loan payment rate rose in the fourth quarter to 4.11 percent of the total, up 76 percent from the third quarter and 142 percent from the first three months of 2007, according to a Stanford Group analysis.

And the problems are likely to get worse. Some home builders are rapidly drawing down so-called interest reserves, the extra cash cushion built into a loan that is intended to protect banks by ensuring that borrowers can pay back interest. Reserves for loans for construction projects that started before the credit crisis will start running out in the next six months. Small business loans could be next.

“We are seeing an uptick in nonperforming loans to small businesses — the local retail stores, service providers, dentists, vets — but off of historically low rates.” said Steven D. Fritts, associate director for risk management policy for the Federal Deposit Insurance Corporation.

Federal banking regulators are particularly concerned about small banks’ exposure to commercial real estate.

In the last six years at community banks, the ratio of commercial real estate loans to capital, a measure regulators use to monitor loan exposure, nearly doubled to a record 285 percent, according to data from the federal Office of the Comptroller of the Currency. Nearly a third of all community banks exceed 100 percent of their capital.

Granted, most banks report that their loan portfolios are holding up and actual delinquencies remain near all-time lows. But over all, the number of borrowers falling behind is growing.

Timothy W. Long, head of supervision for midsize and community banks at the office of the comptroller, said regulators were monitoring lenders closely. He said the industry had not experienced this tough a period in years.

“I would tell you a lot of bankers out there have never had a loan charged off,” Mr. Long said. “The last time we went through this, the loan officers were in junior high.”