Bad loans spiking at local banks

Feb 4, 2008

The risky construction and land-development bets made by Massachusetts' community banks are coming home to roost.

Bad loans are piling up as the financial strength of the state's banking sector continued to whither in the fourth quarter, the latest sign that pressure from a slowing economy and weak housing market is taking a toll on the area's savings and thrifts.

Across the state, banks are reporting a surge in loans that are more than 30-days past due; in many cases, those loans are moving to nonaccrual status, meaning they are beyond 90-days delinquent and unlikely to be paid down anytime soon, if at all.

The fourth-quarter fallout was detailed in dozens of reports filed by local banks with the Federal Deposit Insurance Corp., the quasi-public regulatory agency that insures bank deposits and supervises a swath of financial services activity. As of press time, 123 of the state's 181 banks had delivered the required FDIC reports for the quarter ended Dec. 31. The remainder are due within the next week, according to local banking officials.

The trend hints of darker days to come for local banks, as many piled into the high-margin commercial lending business in recent years to offset a profit squeeze brought on by an inverted yield curve and tough competition among the state's bigger players and other financial institutions.

Banks ultimately will recognize millions in losses or take over troubled properties to move most of these soured loans off the books. Industry experts predict those steps will strain the already limited resources at community banks, forcing many to instate tougher loan standards or pull back from risky lending areas entirely -- much as banks did during the state's last housing downturn in the early 1990s.

"If the loans in question are underwritten well, a bank will likely come out whole," said Gerry Mulligan, the CEO of Riverbank in Lawrence and the state's Commissioner of Banks in the early 1980s. "But looking at these numbers on the surface, you can't tell which loans are recoverable right now."

The fourth-quarter news comes on the heels of an already significant uptick in local loan defaults through the first nine months of 2007. As of Sept. 30, Massachusetts savings banks reported $650 million in past-due and nonaccruing loans. That number was 20 percent higher than the $533.6 million reported at the beginning of 2007 and roughly double the $358 million posted in January 2006.

Within local loan portfolios, the rot is largely centered around the "construction and land development" and "nonfarm nonresidential" lending categories. Many of those debts are tied to large condominium projects and office developments that have been staggered by a weakened housing market and softening economy.

At the end of 2007's third quarter, local savings banks had $280 million in delinquent and nonaccruing loans within those specific lending categories. Such construction and development loans totaled $108 million at the beginning of 2006.

"It's been surprising that there haven't already been a lot of problems in commercial real estate portfolios. Maybe that's about to change," said Suzanne Moot, a banking consultant with M&M Associates in Milton.

In Lowell, the housing slump has left the 120-unit Grandview condo complex largely vacant, forcing one of the project's primary lenders -- Lowell 5 Cent Savings Bank -- to book $18.7 million in nonaccruing construction loans.

Bob Caruso, the bank's CEO, said Lowell 5 is exploring "some alternatives" that involve other property owners and possibly a rental strategy. He said the bank's confidence in Grandview's developer, Tocci Building Corp. in Woburn, has allowed the project to evolve without any legal or foreclosure proceedings.

Caruso blamed Grandview's problems on Lowell's cratering housing market and predatory subprime lending. The city reported 283 foreclosures in 2007, compared to 93 in 2006. "What that's done is depreciated the values of all housing. It's put a stop to home buying in our area."

Lowell 5 has another nonaccruing loan, this one tied to a Merrimack Valley office development, headed for foreclosure proceedings. As of Dec. 31, non-accruing loans represented 3.3 percent of Lowell 5's $697 million in assets. Among all local savings banks, that percentage was .87 percent as of Sept. 30. It was .65 percent a year earlier.

During the local banking sector's crisis in the 1990s, it was not uncommon to see banks with 10 percent of their assets tied up in bad loans. Many of those lenders survived to see another day. Experts agree that, in today's banking environment, a 2 percent ratio of bad loans-to-assets is likely enough to get the attention of regulators.

It's not just small banks that are being hurt, either. At Middlesex Savings Bank in Natick, the state's sixth-largest retail bank ranked by deposits, delinquent loans almost doubled to $37.4 million in the fourth quarter. That figure stood at $19.7 million Sept. 30.

Middlesex declined to comment.

"Even experienced guys can make mistakes in this market," said Steve Costello, a senior executive at Bank of Canton. The $828 million bank saw its nonaccruing loans jump 22 percent to $9.1 million in the fourth quarter.

Costello largely linked the increase to a troubled big residential project.

The situation seems to be spooking banks in other ways, too. Last week, Norwood Co-operative Bank and Walpole Co-operative Bank ended months of merger negotiations after due diligence uncovered, among other things, problems in Norwood's loan portfolio, according to people close to the matter.

The bank saw its delinquent loans jump 58 percent to $17.8 million during the fourth quarter. That number was up 356 percent from the $3.9 million reported a year earlier.

Norwood officials declined to comment. Calls to Walpole Co-op were not returned.

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