Provisional Situation

Provisional SituationBy Francis X. GilpinAssociate EditorHow much is too much?That question vexes bank officials whenever they try to predict which loans will go bad and how much to set aside to cover potential losses.Since 2002, lenders in desirable coastal and other markets across America have reaped solid profits from a vibrant real estate market. Bankers responded by lightening their loan-loss reserves. Defaults have been few, and bankers have been able to unload most distressed properties at little or no loss.Bankers on the Gulf Coast appear to be no exception. They have been lowering their reserves since the middle of 2004, according to a Gulf Coast Business Review analysis of banks from Pasco County south to Collier County.The analysis was limited to 59 banks open at least a year. The provision for loan and lease losses as a percentage of average assets is a standard measurement of the charge that a bank takes against earnings to build a loss reserve. The average provision was 0.54% for the quarter that ended Sept. 30, 2004. The average had dropped to 0.36% a year later.But real estate prices and sales are cooling. Defaults are expected to rise with interest rates, especially among homebuyers who used creative financing to postpone paying down the principal balances on their mortgages.What will bankers do now?Reserves get attentionCharles G. Brown III, chief executive of Englewood Bank, doesn't think he and his colleagues will allow economic conditions to dictate reserve policies. They remember the commercial real estate boom and bust of two decades ago. "You won't see any wild fluctuations because of the experience in the industry in the late 1980s," says Brown.Brown is also president of Charlotte State Bank in Port Charlotte. Wauchula-based Crews Banking Corp. owns both banks. Brown says he tries to keep his reserve for bad debts in a range between 1% and 1.25% of total loans.Englewood Bank's average reserve over five recent quarters examined by the Review was 1.32%. Charlotte State's average reserve for the same period was 1.20%.Loan-loss reserves get considerable attention from all sorts of government regulators because of their potential to impact a bank's bottom line.James E. McNulty, a finance professor at the Florida Atlantic University in Boca Raton, says the concept of loss reserves isn't easy for somebody outside of the industry to grasp. "It is a little strange for a bunch of people to be sitting around a table deciding what their earnings are going to be, after the fact," says McNulty.When executed properly, however, a consistent reserve policy shields banks and their shareholders from unexpected big hits to quarterly or annual earnings when loans have to be written off. "That number can jump all over the place," McNulty says.One big, bad loan at a small community bank can throw an institution's numbers off for a while.Bradenton's Horizon Bank, for example, had the fifth-highest average percentage of non-current loans to gross loans for the five quarters examined by the Review. Non-current loans include obligations that are 90 days or more past due.But Charles S. Conoley, Horizon's president and chief executive, says that high average was unusual. The bank had a commercial real estate loan for around $1 million go south. Fortunately for Horizon, Conoley says, the property was worth double the loan amount. For the most recent quarter that ended Sept. 30, the bank's non-current loan ratio was much improved.Conoley says industry regulators typically allow community banks that specialize in residential mortgages, such as Horizon, to maintain lower loss reserves than banks with greater exposure to construction and land development loans.Conflicting goalsLinda B. Charity, director of the Florida Division of Financial Institutions, agrees that development loans can be riskier because, if something goes wrong, the full value of the collateral may not be available to the lender. But reckless home mortgage lending also can be dangerous, says Charity, such as when a bank is predatory or makes too many loans for amounts that exceed property values.Experts say the regulatory scrutiny acts as a disincentive for bankers to manipulate their reserves for the purpose of smoothing out earnings from quarter to quarter. But that doesn't mean the government agencies always work in harmony.Conoley says the Federal Deposit Insurance Corp. and the U.S. Securities and Exchange Commission have been at odds in the past over bank reserve policies. The stock of his bank's holding company, Horizon Bancorporation Inc., is publicly traded.The FDIC encourages high reserves because the agency has to cover insured deposits in the event that too many bad loans sink a bank. But the SEC doesn't want banks to be tapping their reserves during a bad quarter just to enhance earnings.State bank regulator Charity notes that there is a third agency watching loss reserves: the Internal Revenue Service. She says the IRS is suspicious of unusually high reserves. Uncle Sam doesn't want surplus revenue to be tucked away in a bad-debt fund when it should be getting taxed as profit.Card risksA Tampa bank had the highest average reserve on the Gulf Coast, at 3.60% of total loans. But TCM Bank has a good reason.All the limited-purpose bank does is handle credit-card accounts for its owner, ICBA Bancard, a payment services subsidiary of the Independent Community Bankers of America. TCM also had the highest ratio of non-current loans at 1.70%.Pelican National Bank had an average non-current loan ratio of 0.56%, which was in line with Englewood and Horizon banks. But the Naples bank reported among the five lowest loan-loss reserves on the Gulf Coast.And Pelican National wasn't doing much to increase the reserve, should those delinquent loans not get repaid. Pelican National was one of three banks with the lowest average provision-to-assets ratio.Pelican National President Howard Montgomery wasn't available for comment. Kenneth Werner, a Pelican National vice president, told the Review that he wasn't authorized to speak for the bank, which reported a $755,000 operating loss for the quarter ended Sept. 30.The bank's Michigan-based owner, Pelican Financial Inc., is merging with Stark Bank Group Ltd., an Iowa holding company, in a deal valued at $28 million.Pelican National has been operating for two years under a memorandum of understanding with federal banking regulators. The specific conditions set down in the memo weren't disclosed in a securities filing by the bank's owner.More comfortable at Southern CommerceEight months later, Thomas L. Wilson still remembers the headline - "Southern Discomfort" - on our profile of Southern Commerce Bank."The discomfort is gone," the bank's chairman, president and chief executive told the Review last week.The Federal Deposit Insurance Corp. has lifted a 2002 cease-and-desist order against the Tampa bank, which was accused of engaging in unsound lending practices. Federal regulators are apparently satisfied that Wilson has cleaned up Southern Commerce's loan portfolio and restored the bank's capital position."I'm pleased that they came around to acknowledging it," says Wilson. "The way the regulatory process goes, they're slow to bring it and slow to take it away."Southern Commerce, with $93 million in assets as of Sept. 30, is a one-office bank that boasts an expertise in Small Business Administration loans and wholesale mortgages, using cutting-edge technology to do both more efficiently than competitors.Wilson says the bank is enjoying its best year in 18 years of operation, in terms of growth and profitability. In a year's time, Southern Commerce's assets have increased 36% from the Sept. 30, 2004, total of $68 million. Net income rose almost tenfold to $604,000. That improved Southern Commerce's return on equity so far this year to 8.24%, up from a meager 0.97% for the first three quarters of 2004.He hopes to get Southern Commerce's return on assets above 1% by the Dec. 31 closing of the 2005 books. The ROA was at 0.96% through the first nine months.That return might be considered mediocre, says Wilson. But Wilson says he is proud to have accomplished it while having to spend more than usual on regulatory compliance.