Banks Facing Up to Reality of Diminished Values

By Jim Freer

This year, reality is sinking in at many community banks that have high ratios of noncurrent land development and other real estate loans.

"They realize," said Kingsley Greenland, chief executive officer of the Boston loan-sale adviser DebtX, "that the values, not just of the loans but of the collateral, are not going to come back any time soon."

Thus, many such banks are looking to sell some of these loans — a change from their previous strategy of continuing to restructure weak credits while trying to delay writedowns.

Some are turning to advisers like DebtX that market bank loans to institutional investors.

Others are speeding up their real-estate-owned sales, provided the discounts are not too steep on undeveloped land and stalled housing tracts. Their goal is to sell properties this year rather than incur tax liabilities and other costs as they wait for a housing market rebound.

The $7 billion-asset United Community Banks Inc. in Blairsville, Ga., began that strategy last year because "we cannot predict when prices will start reversing," said David Shearrow, executive vice president and chief risk officer.

Some bankers and advisers expect a new round of banks' and their holding companies' setting up "bad bank" subsidiaries to hold noncurrent loans and REOs.

One example is BankAtlantic in Fort Lauderdale, Fla., which in March transferred $101.5 million of noncurrent loans to a newly formed asset workout subsidiary of the $6 billion-asset parent, BankAtlantic Bancorp.

Almost all the loans were so-called land bank loans to Florida residential developers whose builder clients did not carry out deals to buy lots after the housing market began to soften in late 2006.

Alan Levan, the chairman of BankAtlantic and its holding company, said using an entity that is not part of the bank adds flexibility for timing loan sales. The subsidiary could become a joint venture partner in some developments after the housing market begins to rebound, he said.

Meanwhile, some banks are turning to traditional-style auctions, complete with bidding and the hammer falling, to unload housing construction loans and undeveloped properties.

J. Durham & Associates in Albany, Ga., is to hold the first in a series of Atlanta-area auctions of bank-owned commercial real estate properties and undeveloped land in late June.

Many publicly traded banks are among those that have decided to sell loans and REOs quickly — rather than face the prospect that prices may still be falling late this year and into 2009.

Analysts and investors "are comparing these banks to their peer groups and asking, 'How are you managing your nonperforming assets and REOs?'," Mr. Greenland said. "A way to stay ahead is to not wait to foreclose but to sell the loan before it gets to foreclosure and mitigate your losses."

A growing number of banks are taking a "pay now rather than pay later" approach to selling loans and accepting discounts, said Christopher Marinac, the director of research at the Atlanta investment bank FIG Partners.

DebtX, which also sells nonproblem loans to institutional investors, sold loans for about 100 banks last year.

That total could double this year, Mr. Greenland said.

Cowlitz Bancorp. in Long-view, Wash., with about $500 million of assets, has been selling real estate and commercial loans through DebtX since 2003.

Its latest DebtX sale was an acquisition and development loan to a developer near Portland, Ore., for which it received "just under 50 cents on the dollar," said Cowlitz president and CEO Richard Fitzpatrick.

The single-family home project stalled because several builders had backed out of contracts to buy lots.

Cowlitz might have spent three to five years trying to sell the project if it had taken it through foreclosure, Mr. Fitzpatrick said.

"We sold, received some cash, and moved on," he said.

Still, in sales before this year, including some of nondistressed loans, Cowlitz had gotten "north of 85 cents on the dollar" on some DebtX sales.

This year, Cowlitz took possession of another home building project near Portland that it is marketing itself — again willing to accept a discount rather than absorb several years' holding costs.

Some banks with problem loans and their borrowers are turning to private lenders, such as Forman Capital in Delray Beach, Fla.

Forman Capital's lending in Florida and other states has been on nondistressed commercial properties.

Now, with the number of noncurrent bank loans growing, CEO Brett Forman said his company will consider buying distressed housing development loans. Mr. Forman and other private lenders have more flexibility than banks in structuring loans, including those for distressed debt.

Data from the Federal Deposit Insurance Corp. show the market for distressed bank real estate debt has grown.

From Dec. 31, 2006, and Dec. 31, 2007, the industry's noncurrent ratio for all real estate loans grew from 0.80% to 1.71%. The noncurrent rate on construction and development loans soared from 0.71% to 3.15% during those 12 months.

Among banks with assets of $1 billion to $10 billion, the noncurrent ratio for all real estate loans rose from 0.67% to 1.53%, and from 0.76% to 3.05% on construction and development loans.

The FDIC had not released its first-quarter industry data by press time, but if earnings reports of publicly traded banks are an indication, the numbers are likely to get worse. Many community banks' quarterly earnings included significant increases in noncurrent loans to home builders.

United Community Banks reported that its ratio of nonperforming assets to total assets rose from 0.56% at the end of last year to 1.07% at March 31. Its noncurrent loans and REOs are primarily for housing construction in the Atlanta market.

United has been able to sell REOs aggressively because it exceeds all measures required for being considered well-capitalized, Mr. Shearrow said.

Writedowns have ranged from "0 to 20%" on sales of completed projects and "anywhere from 15 and 20 to 50%" on lots and undeveloped land, he said. Buyers usually are local developers and individuals, he added.

United uses its own staff to find buyers and tries to get properties off its books within 90 days of foreclosure. It prefers to foreclose and sell properties rather than try to sell problem loans before they reach foreclosure. In addition to being behind on loan payments, housing developers often are owed money by subcontractors and have liens, Mr. Shearrow said.

Setting up a subsidiary for problem loans is another strategy that requires a bank to exceed well-capitalized levels, said BankAtlantic's Mr. Levan.

The bank and its holding company satisfy the requirement. The holding company added to its capital in March by selling 2.1 million shares of Stifel Financial Corp. for $82.2 million and used much of the proceeds to buy loans from the bank.

"As opposed to being concerned about capital at the bank level, we can be more creative in working with borrowers and in completing foreclosures as the case may be," Mr. Levan said.

Steven Fritts, the FDIC's associate director for risk management policy, said the agency is not hearing much about banks setting up "bad bank" affiliates. Still, he said, "It can make sense to isolate those assets. It allows loan officers to focus on developing new business."

State laws on corporations and Federal Reserve and Office of Thrift Supervision rules on holding companies are what Mr. Fritts calls the "dominant legal drivers" for setting up such subsidiaries.

Taking foreclosed properties to auction is an alternative to managing them in a bad bank setup.

The Martin Realty Advisors in Alpharetta, Ga., and joint venture partner J. Durham & Associates have recently been advising several banks in southeastern states about auctions. "This is at an early stage," said Joe Durham, the president of J. Durham Associates. "We will start seeing more banks realize that they need to sell now because the markets are not getting better."

Mr. Durham said the first auction featuring bank assets will include undeveloped land, stalled condominium projects along the Florida Panhandle coastline, and stalled single-family projects around the Southeast.

Those kinds of properties are prominent as collateral for loans that DebtX sells in an online bidding process to more than 3,500 institutional investors. Mr. Greenland said he anticipates vacancies rising at numerous "marginal shopping centers," and that loans on retail properties could be the next to falter.

DebtX's business includes a five-year agreement with the FDIC, signed last year, to sell real estate assets that are in receiverships.