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New Crisis Threatens Healthy Banks
Late Loan Payments Hurt Smaller Lenders That Dodged Subprime Mess

By David Cho
Washington Post Staff Writer
Sunday, June 22, 2008

Increasing struggles by consumers and businesses to make payments on a variety of loans, not just mortgages, are setting off a new wave of trouble in the financial sector that is battering even institutions that had steered clear of the subprime-home-loan debacle.

Late payments on home-equity loans are at a record high, according to fresh data from the Federal Deposit Insurance Corp. The delinquency rates on loans for cars, small businesses and construction are spiking to levels not seen in a decade or more.

Unlike last year, when soaring mortgage defaults sparked a crisis of confidence in the financial system, the root of these problems is the downturn in the broader economy. Simply put, consumers and businesses are strapped for cash with job losses growing and retail sales falling, economists said.

"We are not finished with the mortgage problem, but you are starting to see increased delinquencies in other forms of consumer debt," said Paul Kasriel, an economist at Northern Trust Securities. "We are in the eye of the hurricane. We had the first wave of the credit crisis, and it was quite damaging. But there's another wave coming, and it's likely to be as destructive."

The institutions most at risk in this new phase of the credit crisis are regional and local banks, many of which stayed away from subprime mortgages. These firms are key drivers of economic activity in communities across the country. Without them, consumers would lose a source of personal loans. Small businesses would struggle to stay afloat. Construction companies often can't finance local projects without these banks.

Because they have fewer options than big Wall Street firms for raising emergency funds, these regional and local banks tend to be more vulnerable in a crisis.

In the Washington area, the stock prices of several local banks have already plummeted, with shares of Virginia Commerce Bank falling nearly 50 percent and Alliance Bank dropping about 45 percent since the beginning of the year.

Others swung to a loss in the first quarter after remaining profitable through last year's financial turmoil. The Federal Reserve put at least one, Millennium Bankshares of Reston, under close scrutiny this month out of concern for its financial condition.

The market values of some of these banks have fallen below their book value, or what accountants say the firms' assets are worth minus their debts. This is a sign that investors expect more losses this year. The market value of Virginia Commerce is about $142 million, below its book value of about $175 million, while Alliance's market value has dwindled to $18.4 million, compared with its book value of $44 million.

The situation is worse in the Southwest and Midwest, where several community banks are teetering and a few have already collapsed.

Even as this second wave erodes the stability of the country's banks, it is already taking a heavy toll on ordinary borrowers. Vanessa Chavez and her family took out a home-equity loan in 2003 to pay for some remodeling of their District home and for the medical bills for her pregnancy. Their monthly payments, once the new loan was added to their mortgage, jumped from about $2,000 to $3,700.

Chavez had hoped to help pay the bill by getting a high-paying job. But the economic downturn sabotaged her plan, and she finally took a job as an assistant manager at a Domino's Pizza. Late last year, her mother declared personal bankruptcy, hoping to get the house payments lowered.

"We're doing everything we can to stay in the house," said Chavez, 21. "We've been going through tough times, so we're trying to do as much as we can, even if it is killing us."

For lenders, there is little recourse when a home-equity loan defaults or a homeowner declares bankruptcy. They can seize the collateral for the loan, in this case the house, only after the primary mortgage is paid off.

From October to March, $6.7 billion in home-equity loans became delinquent, increasing the total by 45 percent, according to SNL Financial. The delinquency rate is now 2.24 percent, according to the FDIC, which began tracking the data in 1991.

Losses at banks are going up as a result. J.P. Morgan Chase absorbed $450 million of home-equity-loan losses in the first quarter, up from $248 million in the previous quarter. It said its total home-equity losses could double by the end of the year.

Smaller banks have even more exposure to such loans. Overwhelmingly, the institutions that hold the most home-equity loans are regional banks, such as SunTrust Banks and National City, according to Fitch Ratings.

Late payments and defaults in every other major category of consumer debt also rose in the first quarter, the American Bankers Association reported. Auto loans issued through car dealers have a delinquency rate of 3.13 percent, the highest since at least 1990, according the ABA.

"The rise in consumer credit delinquencies is consistent with a rapidly slowing economy," said James Chessen, the ABA's chief economist. "Stress in the housing market still dominates the story, but it's a broader tale of an overall weak economy."

Businesses are also feeling the pain of relying too much on credit. Construction and development loans, a specialty of regional and local banks, hit a delinquency rate of 7.18 percent at the end of March, the highest in 14 years, according to the FDIC. In October, the rate was 3.22 percent.

The trend worries regulators. "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," Comptroller of the Currency John C. Dugan said in a speech last month.

In the Washington area, home-equity and commercial real estate loans represent a significant share of the banking business, and the trouble in these two areas is a source of deep concern, said Peter Fitzgerald, a former U.S. senator from Illinois who founded Chain Bridge Bank in McLean.

"The banks around here all have an extraordinary concentration in real estate," said Fitzgerald, adding that his bank has followed conservative lending practices since opening in August. "And what will happen is you will have some economic Darwinism. The banks with the strongest balance sheet will not only survive but will go on to prosper."

Even the region's healthiest banks are anxious about the prospect of a prolonged recession.

"We are pretty upbeat right now; our guys are feeling really good," said Bernard H. Clineburg, chairman and chief executive of Cardinal Bank. The firm recorded a profit of $2 million in the first quarter, attributing the result to conservative lending policies. "But if people keep losing their jobs, at some point everyone is going to feel the pain," Clineburg said. "If it keeps going, I don't think anyone escapes."

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