Lending Lessons

Lending Lessons

BANKING by Mark Gordon | Managing Editor

Loan loss reserve portfolios are increasing up and down the Gulf Coast, and for good reason: Banks don't want to be left without a seat when the real estate music stops.

Will it happen again?

Up and down the Gulf Coast, that's the question lingering in the minds of bankers, developers, contractors and just about any executive who has money in a bank. At chamber breakfasts, power lunches and rubber-chicken dinners, it's been the topic du jour: The 'it' is Coast Bank of Florida and the 'again' is a breakdown in construction loans when a larger builder fails.

Bradenton-based Coast's breakdown stems from when a builder failed to complete 482 homes it was working on in Sarasota and Charlotte counties in late 2006. That Jan. 19 announcement led to a string of problems, as $67 million out of $110 million of the loans were already disbursed; the parent company of the bank, Coast Financial Holdings, has since seen its stock plummet, has been sued by several borrowers and entities and is looking into a possible sale of the bank.

As most things go in the complicated, competitive and heavily regulated banking industry though, there's no uniform answer to the question. Just about every banker is confident it can happen again, and so are regulators at the Federal Deposit Insurance Corp., who even before the Coast debacle released guidelines suggesting how much banks should have in residential construction and commercial real estate loans as a percentage of overall capital. (See related story and chart).

But as to will it happen again, and will it happen to the extent of Coast, the answers are mixed. From Tampa to Naples, most bankers familiar with the Coast story say that situation is an aberration, as it was the result of several factors crashing together, not just bad loans.

Coast-specific problems included a combination of the following happening at once, several bankers told the Review: A slumping real estate market; lack of diversification in loans and overexposure to one builder; alleged communication breakdowns between executives and the board; lack of senior, experienced lenders; lack of proper risk-management controls; and a series of wrong, and unchecked, decisions by a now-fired loan manger.

It's not only about the numbers, says Charles Murphy, president and CEO of the Bank of Commerce, based in Sarasota. It goes a lot deeper than that. I don't think we've heard all of what's happened at Coast.

Coast officials, through spokesman and advisor Tramm Hudson, declined to comment specifically on any allegations.

Regulation adherence

Meanwhile federal regulators at the FDIC get paid to regulate, and in doing so they are attempting to answer the 'will it happen again question' with a resounding 'no.' The FDIC guidelines, imposed Dec. 6, call for holding construction and land development loans under 100% of overall equity capital and keeping commercial real estate loans under 300% of equity capital.

Banks are just having more and more reliance on commercial real estate loans, and when you see banks having too much concentration in one area, we will send out guidance, FDIC spokesman David Barr says. We will monitor and expect banks to adhere to the guidelines.

In this case, though, many bankers are shrugging their shoulders, as opposed to shuttering in fear of the government. That's because on the Gulf Coast, having a high concentration of loans in real estate is akin to a scuba diver having a full oxygen tank: It's a lifeline.

Larry Johnson, president and CEO of Fort Myers-based Old Florida Bank, echoes the comments of many of his peers when he says that most of us are substantially over the guidelines, including Old Florida.

To wit, an analysis of Gulf Coast banks performed for the Review by Charlottesville Va.-based research firm SNL Financial shows that as of the end of 2006, 46 of 82 Gulf Coast-based community banks, 78%, are over both thresholds set forth by the FDIC. Another four banks are over the 100% construction and land development loan threshold and another eight banks are over the 300% limit for commercial real estate loans.

Many of the banks on the FDIC's overexposed list are a who's who of top Gulf Coast performers, including Naples-based Orion, Sarasota-based Century, Tarpon Springs-based Florida Capital and St. Petersburg-based Synovus. Many bankers cite that as evidence that being over the limits isn't necessarily bad.

Orion, for example, was 459% over the recommended threshold for construction and land development loans and 227% over the recommended threshold for commercial real estate loans in 2006, numbers that put it second on the overexposure list. Yet the bank is a mainstay of top community bank performing and profitability lists not just on the Gulf Coast, but nationwide, too. American Banker even recently named chairman, president and CEO of Orion, Jerry Williams, its Community Banker of the Year for guiding the privately-held bank.

Then again, the bank with the highest percentages over both FDIC thresholds according to SNL is Coast, which as of the end of 2006 had 522% of equity capital greater than the thresholds for construction and land development loans and 231% of equity capital greater than thresholds for commercial real estate loans.

The rub, bankers say, is in making sure a loan breakdown isn't the ultimate result of being over the guidelines. It doesn't say you can't do it, Murphy says. It says you have to have the system in place to monitor the loans.

The FDIC guidelines also don't refer to asset loan loss allowance or net charge-offs due to loans, other numbers that can be problematic if not monitored. And, no surprise, those ratios have increased at many Gulf Coast banks over the past year.

Lessons learned

The lurking anxiety has been an impetus for some bankers to reexamine their internal operations.

Some have gone as far as to go over every loan on the books, while others have looked at their controls and are satisfied the proper procedures are in place. Many banks have increased loan loss reserves, just in case there's a problem.

I hope all banks learn a lesson from this, says George Najmy, president and CEO of Bradenton-based First Priority Bank, with a headquarters down the street from Coast. It's not good for any of us.

Tom Quale, president and CEO of Sarasota-based Landmark Bank is taking the proactive approach. Literally days after the Coast story broke, Landmark credit department employees began re-reading every residential construction loan in the bank's portfolio. The staff then came up with a table it shared with its board on the particulars of each loan.

Quale says employees also reviewed loans for commercial construction, vacant land and development projects. They looked at each aspect of the loan, such as insurance and pay schedules.

We are doing a whole lot more monitoring, says Quale. We almost re-underwrote our entire portfolio.

Like Quale, Johnson, at Old Florida Bank, took the Coast news as a chance to review policies at his bank, which has four branches in Fort Myers-Naples.

Protect the Brand

Bankers up and down the Gulf Coast say they have learned valuable lessons from Coast Bank's loan failures. But it's possible that no bank has learned more than Coast itself.

Some lessons were reinforced versions of basic banking tenets, while others were new approaches to growth and long-term strategy, says Tramm Hudson, a retired banking executive who has been consulting with Coast's board and top advisors since late January.

Taken all together, Hudson says the experience will make Coast better in the long run, although short-term, the bank's future is cloudy. Current problems range from the slumping stock price to defending itself against lawsuits stemming from the loan debacle. A sale is possible, too.

Meanwhile, Hudson says bank executives are using the situation as a guide for improving the overall fortunes of the bank - and to make sure something similar never happens again. The bank is also putting the brakes on its grow-first, ask-questions-later strategy it had been conducting from its 2000 founding until late last year. There are better days ahead, says Hudson.

Overall, the lessons Coast executives have learned and re-learned over the last two months serve as a reminder to them, as well as any other banker - or executive in any other industry - that continued business success is never guaranteed, no matter how good the past was. Those lessons include:

• Know the numbers: Hudson says Coast executives now realize they need to have an everyday awareness of all the financials within the bank, and they have to get behind the numbers to the point where there are no surprises.

• Protect the brand: Bankers need to take steps internally to see that major problems are avoided before they have a chance to become major problems in the first place. The level of public scrutiny Coast executives faced, as well as the perception of the bank as a failure, proved to be major distractions to solving the core problem. Says Hudson: Reputation risk is oftentimes underrated in banking.

• Regulating relationships: As a local bank and a public company, Coast has to answer to several regulatory agencies, with several levels of enforcement. Coast executives were aided in the early going by already knowing the right people to talk to.

-Mark Gordon

REVIEW SUMMARY

Industry. Banking

Trend. Construction loans are proving risky for local banks.

Key. Federal regulators are nervous about banks becoming overexposed to loans in the commercial real estate and residential construction areas. Local bankers have taken this environment as an opportunity to re-check everything.

It could happen to you

Many Gulf Coast banking executives are quick to point out that federal banking guidelines are just that, guides. Surpassing the guidelines, such as the ones the Federal Deposit Insurance Corp. put out Dec. 6 regarding how much banks should have in residential construction loans as a percentage of overall capital, is acceptable, this theory goes, as long as the proper controls are in place.

If you come under their radar, says Larry Johnson, president and CEO of Fort Myers-based Old Florida Bank, you better show them you know what you're doing.

Executives at First Community Bank of Southwest Florida were pretty sure they knew what they were doing, too, back in 2001, when they entered the field of residential construction lending at what turned out to be the beginning of a five-year Gulf Coast housing boom.

But four years later, bank executives still found themselves consenting to an FDIC cease and desist letter, partially after the agency criticized the bank for having too high a concentration in residential construction loans. (See 9/2/05 Review).

The lending program went from being First Community's biggest revenue stream to being its biggest headache. The first step was to abandon the business line and go back to its roots in commercial lending and adjustable rate mortgages.

The second and ongoing step - unloading a combination of about 50 foreclosed lots, half-built and finished homes in Cape Coral and Fort Myers - is proving to be more troublesome. The bank has been sitting on those because the market slowdown left many borrowers in a lurch, where they couldn't afford the payments.

We are working our way out of it, First Community President and COO David Hall says. At the end of the year, we'll be glad to move on from it. My goal is not to own homes and lots.

Hall has been aggressive in trying to unload the properties, adding that he will take a loss in some situations just to get the loans off the books. The bank is hawking the properties near and far - from fliers at local real estate breakfasts to advertising in European and South American newspapers.

Hall says the remaining properties and loans in the First Community portfolio represent about $12 million, a small percentage of the $353 million it had in the program during its peak earlier in the decade.

-Mark Gordon