Small Banks, Tight Credit

When Kassie Rempel, owner of SimplySoles, a D.C.-based shoe retailer, went to Eagle Bank for a loan to open her first store, she had to personally guarantee the loan. "It gave me pause, but not enough to not proceed with the paperwork," she says. (By Dominic Bracco Ii -- The Washington Post)
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The delinquency rate for mortgage loans that sit on bank balance sheets is relatively low. Most mortgage loans are made by mortgage companies and sold to investors. Overall, about 8.8 percent of home mortgages were delinquent or in foreclosure as of June, according to the Mortgage Bankers Association.

Delinquency rates on credit cards, home equity and other consumer loans continue to climb but remain lower. Mortgage loans for commercial properties and other loans to businesses have been relatively unaffected.

Many small banks focused on construction lending because it was one of the few areas where they could compete with larger banks. In other areas, large banks used their scale to offer prices and products that small banks couldn't match, from free checking to lower rates on mortgages.

But construction lending was an area where smaller banks could compete by cultivating relationships with developers and embracing risk. And during the real estate boom, it was immensely profitable, leading, among other things, to the founding of many new banks, some of which appeared to be functioning essentially as real estate investment clubs.

Now the tide appears to be turning.

The profit margins of small banks that focused on construction lending shrank below the margins for other small banks in the first quarter of 2008 for the first time since the real estate boom began, according to an analysis by the Office of the Comptroller of the Currency.

Just as larger banks have struggled with defaults on loans to homeowners, smaller banks are now struggling with defaults on loans to home builders.

"We are starting to see the onset of a second round of effects primarily concentrated in residential and commercial development lending that affects more institutions and probably will play out over a longer period of time," FDIC officials said during a news conference yesterday.

A list of troubled banks kept by federal regulators included 117 names at the end of June, up from 90 institutions at the end of March. Those troubled institutions had total assets of $78.3 billion, up from $26.3 billion in March. The June numbers include some banks that have since failed, including IndyMac Bancorp, which had assets of $32 billion.

Further increasing the pressure on banks, FDIC officials confirmed that they will discuss in early October an increase in the insurance premium banks are required to pay on deposits to replenish the insurance fund after the expenses of recent failures.

Regulators and industry officials emphasized that the vast majority of banks remain in strong health. James Chessen, chief economist at the American Bankers Association, noted that total lending volume rose in the second quarter.

"The industry as a whole remains well-positioned to meet the credit needs of local communities," Chessen said.