Monday, March 8, 2010

‘On the Edge’ Banks Facing Writedowns After FDIC Loan Auctions

A Federal Deposit Insurance Corp. plan to auction more than $1 billion in assets seized from failed banks next month, including a loan to build a , may trigger write downs that weaken lenders nationwide.

Almost half of the loans were originated by Silverton Bank N.A., whose collapse last May was the biggest in Georgia history. Community banks that joined Silverton in providing $80 million for the 237-room W Hotel and condominium complex in Atlanta, as well as backing for 39 other projects, could be forced to write down their stakes to reflect sale prices.

The auctions may have wider repercussions. Of the $50.4 billion in loans seized from failed banks currently held by the FDIC, 63% involve participations by other lenders, according to data provided by agency spokesman Greg Hernandez.

“These banks can’t believe that the regulator they pay to protect them is going to sell these loans to someone who can flip them and cause them serious losses,” said Robert Reynolds, a lawyer at Reynolds Reynolds & Duncan LLC in Tuscaloosa, Alabama, who represents 25 lenders that took part in financing the W Hotel. “Our banks just cannot believe they’re being treated in a way that ultimately hurts the FDIC’s insurance fund, because some of them are right on the edge.”

Bank Failures

A total of 140 banks failed last year, and FDIC Chairman Sheila Bair said the number may be higher this year. It stands at 26 as of March 6. The agency said on Feb. 23 that 702 banks were on its “problem” list as of Dec. 31, up from 552 at the end of the third quarter. The FDIC’s insurance fund had a deficit of $20.9 billion at the end of the year.

“This whole thing is a mess waiting to happen across the country,” said Geoffrey Miller, a professor of securities law at New York University and director of the Center for the Study of Central Banks and Financial Institutions.

“Unlike the subprime mortgage problems, which hit mostly bigger financial institutions, the commercial real estate crisis is going to hit mostly smaller and regional banks,” Miller said. “It was common for them to make these loans and buy participations. It’s a systemic problem that the FDIC has to deal with.”

That view was echoed by John J. Collins, president of Community Bankers of Washington in Lakewood, Washington. Some banks in his state have expressed concern that they may have to take write downs as a result of the FDIC sale of seized loans in which they participated, he said.

“We have a number of banks teetering on the edge, and we don’t need this problem,” Collins said in an interview.

‘Decreases’ Value

If a loan is sold to a buyer who restructures it at less than book value or forecloses on the property, participating banks would have to write down their stakes, said Russell Mallett, a partner at PricewaterhouseCoopers LLP in New York who specializes in bank accounting. Absent a restructuring, banks have flexibility in how they value loans, he said.

“This is not a perfect real estate development, but it could work its way out of its problems if they get more funding and we’re patient,” said Ralph Banks, executive vice president of Merchants & Farmers Bank of Greene County in Eutaw, Alabama, which owns less than $1 million of the loan.

That view was supported by executives at two other lenders that bought participations who asked not to be identified because their banks’ roles as owners of the W Hotel loan haven’t been disclosed.

The FDIC has a policy of not splitting servicing rights from loan ownership because it “decreases the value of those assets,” said Hernandez, the agency spokesman.

‘Deal With Themselves’

Reynolds said the banks he represents may bid for Silverton’s share of the W Hotel loan if they can come up with the capital in order to stave off write downs. Some of the lenders are already in financial trouble, he said, declining to identify them. One that participated in the loan, Florida Community Bank in Immokalee, Florida, failed on Jan. 29.

Silverton, a wholesale bank based in Atlanta with no consumer operations, was owned and overseen by more than 400 community lenders in the region. It was founded in 1986 and provided banking services, including wire-transfer systems, bond trading and credit-card operations, to about 1,400 institutions in 44 states.

Reynolds said the banks that owned Silverton, some of which had representatives on its board, never imagined it would fail.

“My clients had a long, successful record with Silverton,” Reynolds said. “When they signed their participations, they felt they were signing a deal with themselves because they all owned the bank. We all thought this was a way to diversify risk.”

Silverton Failure

The bank’s troubles began in early 2007, when it changed from a state to a national charter so it could accelerate its growth, according to a report by the Treasury Department’s Office of Inspector General, which reviews failures of banks regulated by the Office of the Comptroller of the Currency.

Silverton’s commercial real estate lending rose to $1.2 billion at the end of 2008 from $681 million at the end of 2006, the report said. The bank had $4.1 billion in assets when it failed last year, and the FDIC said the closing will cost its insurance fund $1.3 billion.

“The board and management either chose to ignore or failed to acknowledge the indicators of a declining real estate market,” the inspector general’s report said.

Defaults Double

Real estate loans at U.S. banks that are at least 90 days overdue or that are expected to default almost doubled in 12 months to 7.1 percent, according to December FDIC data. Non- performing loans for construction and development rose to 16 percent from 8.6 percent.

“This is a situation the FDIC is going to face more, since the number of bank failures is going up,” said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine. “The FDIC is not in the business of managing loans, so they do have to sell them. But they also have to look at the bigger picture and take a global approach by liquidating those assets without hurting the banks that bought participations.”