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Smaller Banks Thrive Out of the Fray of Crisis
People Shift Money From Wall St. to Main St.

By Binyamin Appelbaum
Washington Post Staff Writer
Friday, September 26, 2008

Banks throughout the United States carried on with the business of making loans yesterday even as federal officials warned again that their industry is on the verge of collapse, suggesting that the overheated language on Capitol Hill may not reflect the reality on many Main Streets.

The industry is resilient despite the struggles of some members. Washington Mutual, a troubled Seattle savings and loan that was among the nation's largest mortgage lenders, yesterday was seized by the government and sold to J.P. Morgan Chase.

At the same time, many smaller banks said they were actually benefiting from the problems on Wall Street. Deposits are flowing in as customers flee riskier investments, and well-qualified borrowers are lining up for loans.

"We collect money from local savers, and we lend it in the local community," said William Dunkelberg, chairman of Liberty Bell Bank in Cherry Hill, N.J. "We're doing fine. There are 9,000 financial institutions out there, and most of them are small and most of them are doing fine."

Dunkelberg, a professor of economics at Temple University and chief economist for the National Federation of Independent Business, added that a recent survey of that group's members found that only 2 percent said getting a bank loan was the great challenge facing their businesses.

"If you can't get a loan, my advice is to go see your local community bank," Dunkelberg said.

Even some of the nation's largest banks, which have pushed hard for a federal bailout, deny that the current situation is forcing them to reduce lending. "The strength of our core businesses, capital and liquidity are enabling us to continue to support our customers," Bank of America, the nation's largest bank, said in a statement. It added, however, that the bailout plan would allow more lending.

The most recent Federal Reserve data show that the volume of outstanding bank loans declined 0.5 percent from the last week of August to the second week of September, though it was up more than 6 percent from the corresponding time last year.

There is no question that banks, particularly the largest banks, are struggling to borrow money. Large banks have basically stopped lending to one another. Bank investors also are hesitating. The volume of short-term debt issued by financial institutions, known as commercial paper, fell by $50.3 billion for the week ended Wednesday, even as the volume of short-term debt issued by other types of companies increased slightly.

That has forced banks into the arms of the Federal Reserve. Total borrowing in the last week set a record, at $262 billion, more than doubling the previous all-time high, set the week before last.

The most dramatic indication of the problems facing banks is how they are treating each other. Overnight Wednesday, one measure of the cost of borrowing from another bank, the London interbank offered rate (Libor), posted its largest spike for three-month loans since 1999.

Even more startling to market observers was the difference between the interbank rate and the price paid by the government to banks for borrowing their money. The interest rate on a three-month Treasury bill fell to less than 0.5 percent Wednesday, creating a difference of more than three percentage points between the price banks charge the government and the price they charge each other.

"It's a sign that banks don't trust one another," said Richard Marston, a finance professor at the Wharton School of the University of Pennsylvania. "It's a canary in the coal mine; it shows just how distressed those relationships have become."

Large banks use Libor loans as a way to balance the books at the end of the business day. It allows the banks to make sure they're holding enough capital relative to the loans they have made. The inability to borrow -- or to borrow at a reasonable price -- forces banks to make sure they have enough money before they make a loan.

In some cases, that means a loan does not get made.

"Clearly, there are challenges," said Sam Schreiber, Wachovia's president for the mid-Atlantic. He said the cost of loans has increased and the bank has tightened its lending standards. "But when there's opportunities and a client needs credit, we're working to fulfill those needs."

Wells Fargo, one of the nation's largest mortgage lenders, yesterday quoted an interest rate of 9.125 percent on a jumbo mortgage loan, three percentage points higher than the 6.125 percent rate on a standard mortgage. Jumbo loans are riskier: They cannot be sold to the finance companies Fannie Mae and Freddie Mac because of their size. In the Washington area, the category includes loans larger than $729,750. Historically, lenders assessed a surcharge of 0.5 percentage points for the extra risk of holding a jumbo loan.

Smaller banks, by contrast, make few mortgage loans, and their lending is fueled by deposits, rather than borrowing. That has insulated them from the troubles on Wall Street.

"We're drowning in liquidity because people are pulling money out from other places and depositing it with us," said Peter Fitzgerald, chairman of Chain Bridge Bancorp in McLean. "Our bank has benefited tremendously."

Fitzgerald, a former senator from Illinois whose family has been in the banking business for generations, said the current situation struck him as similar to past downturns.

"The banking system did need to slow down," Fitzgerald said. As it does, riskier customers are being turned away. At the same time, banks that overextended are now forced to turn away even good customers. The challenge for Chain Bridge, he said, is identifying the worthwhile customers. The bank has plenty of money to make good loans, he said.

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