Small Banks' Reckoning Day Is Coming

Billions in Troubled Construction Loans

Promise to Pose Test for Regional Lenders

By MICHAEL CORKERY, JENNIFER S. FORSYTH and LINGLING WEI
The Wall Street Journal
July 2, 2008

Wall Street is bracing for regional and small banks to fess up to
large losses from their mounting volume of soured construction loans
made primarily to home builders.

[And, as everyone knows, during the housing bubble which is now
popping -- er, exploding, more accurately -- greedy, unscrupulous,
quick-buck-artist home builders by the tens of thousands were *the*
proverbial poster boys for hiring illegal aliens (typically unschooled
and untrained "day laborers") to erect often-shoddy houses, displacing
the pool of skilled, properly trained, experienced, quality-oriented
American citizen construction workers who'd traditionally built the
nation's homes. (Not surprisingly, Consumer Reports magazine has
already cited the use of illegal alien laborers as a major cause of --
shhhhhh! -- an epidemic of poorly-built new homes acorss America. Look
it up yourself!)

There's a great, hard-hitting and very poignant video clip online
somewhere -- I wish someone reading this would provide its URL in a
follow-up to this post -- in which an experienced U.S. construction
worker (a framer) -- a proud Mexican-American veteran and patriot --
walks inside a shoddy illegal-alien-framed new house frame as he
launches into an extended bitter rant telling how the back-stabbing,
criminal builder replaced him and his son, both English-speaking U.S.
citizens, with fly-by-night, untrained "day laborers" picked-up on the
street, the names of whom even the builder himself who pays them (in
cash, of course) can't be certain.

It is THESE kinds of scumbags, many of whom became millionaires the
past decade by hiring illegal aliens off-the-books (i.e. by committing
massive tax fraud) who are now helping to destroy the nation's banks,
which themselves were undoubtedly the builders' "partners in crime."
-- GeorgeWashingtonAdmirer]

According to the Federal Deposit Insurance Corp., $45.4 billion of the
$631.8 billion in construction loans outstanding at the end of the
first quarter were delinquent. When banks announce second-quarter
results in coming weeks, they are expected to report sharp increases
in loans that builders can't repay. Banks are also facing intensifying
pressure from federal and state regulators to deal with the problem
loans on their books.

WHICH BANKS WILL FEEL THE PAIN?

See a sortable list1 of small and regional banks with sizable exposure
to construction and land loans and with notable delinquency rates.That
will put additional pressure on an already stressed financial system.
Banks have begun to dump bad construction and land loans at discounts,
curtail new lending and halt construction projects that are under way
to preserve capital. Some analysts even see a wave of bank failures as
a possibility.

"Across the industry, the second quarter is going to be a tough
quarter," says Keith Maio, chief executive of the National Bank of
Arizona, a unit of Zions Bancorp, which lent heavily to home builders
and developers. "It's going to continue to be tough until the real-
estate market hits a bottom."

Scores of banks were already suffering headaches by the end of the
first quarter, according to a review by The Wall Street Journal of
FDIC-filed reports by 6,919 banks that make construction loans. The
smallest banks, those with total assets of less than $5 billion, faced
the biggest problems. The WSJ analysis didn't include savings-and-loan
institutions, or so-called thrift banks.

Nearly one in three of the banks analyzed -- or 2,182 -- had
construction-loan portfolios that exceeded 100%% of their total risk-
based capital, a red flag to regulators, although it doesn't mean the
bank is in danger of failing. Risk-based capital is a cushion that
banks can dig into to cover losses.

Even more alarming, 73 of those banks had construction-loan
delinquency rates of more than 25%%. Executives at all of the banks
that responded to questions acknowledged the problems but expressed
confidence they had the capital to weather the storm.

At Bremerton, Wash.-based Westsound Bank, new Chief Executive Terry
Peterson agreed that his bank became "much, much too concentrated" in
construction loans. About 43%% of Westsound Bank's construction and
land loans in the first quarter were delinquent.

Mr. Peterson was appointed CEO recently to clean up the troubled bank,
after regulators issued a "cease and desist" order in March requiring
the bank to change lending practices. "We are pretty much using all of
our human capital to address our loan problems," he says.

Larger regional banks also face mounting construction-loan problems,
but are in decent shape. Thirty-eight of them had more than 100%% of
their total risk-based capital in construction loans at the end of the
first quarter, but only nine of those faced delinquency rates of more
than 10%%.

Over the next few quarters, banks are expected to begin recording much
larger losses. In 2007 and the first quarter of this year, U.S. banks
wrote down just 0.7%% of their residential construction and land assets
as bad debt, according to Zelman & Associates, a research firm. Over
the next five years that figure could rise to 10%% and 26%%, which would
amount to about $65 billion to $165 billion, Zelman projects.

During the housing boom, many small and regional banks doubled down on
construction loans because they were largely shut out of the home
mortgage market dominated by large originators. But now the banks'
difficulties are threatening to sharply shrink the home-building
industry. Credit Suisse analyst Dan Oppenheim estimates that as many
as 50%% of the closely held builders won't survive because of the
tightening lending environment and housing downturn.

Strategies for coping with the problem loans vary widely. Large banks,
such as IndyMac Bancorp Inc. and KeyBank, have been trying to sell
billions of dollars of construction and land loans. IndyMac said in a
filing Monday that it is working with regulators to shore up its
capital. (See related article2.)

"The banks are running as fast as they can to get out of housing,"
says Tom McCormick, president of Astoria Homes, a large, closely held
builder in Las Vegas.

Mr. McCormick is involved in a fight with KeyBank, which recently
initiated foreclosure proceedings on a $24 million construction loan
financing a Las Vegas housing project. Mr. McCormick says the bank
took that action even though his company was current on debt payments.
In court documents, KeyBank says the builder fell behind.

Mr. McCormick says he found investors to buy out his loans at 70 cents
on the dollar, but the bank refused. He also says that KeyBank has
prevented him from closing home sales. "I personally think the fact
that you would punish any innocent home buyer...is shameful," Mr.
McCormick wrote in an email to KeyBank executives. A spokeswoman for
KeyCorp, KeyBank's parent, declined to comment.

Many smaller banks have been more willing to work with struggling
builders rather than foreclose on their projects. But these banks are
coming under pressure from regulators to more aggressively write down
their loans, amid declining real-estate values. This process could
force many more loans into default.

Some community banks are bristling under the regulatory pressure. "The
federal government is being too reactionary," says Damian Kassab,
chief executive of Michigan-based Warren Bank, which reported that 47%%
of its construction loans are delinquent. "They want to see it done as
quickly as possible. I say 'can't we just relax, take a deep breath
and work with the borrowers.'"

Analysts question whether some small banks are putting off
foreclosures because they lack adequate capital to absorb the large
losses.

Banks seeking a quick fix by selling off their troubled loans may find
fewer buyers. Laurence Pelosi, an executive director of Morgan Stanley
Real Estate, a major land investor, told the Pacific Coast Builders
Conference last week that the appetite for distressed residential real
estate may be waning among some investors. "The complexity of the
business and the increasing opportunities in the commercial sector may
lead to a shift away from residential," Mr. Pelosi says. "That will
have a further impact on values."

http://online.wsj.com/article/SB121494953423420859.html