After betting heavily on real estate lending, about a third of Utah's smaller community banks are teetering between collapse and survival after the worst land-value crash in memory.
Nine banks are struggling to collect on development and construction loans representing 36 percent of their combined portfolios. Many loans are overdue to the point of default and are in danger of being written off as total losses.
If the past year is a guide, some of these banks may fail. Since January 2008, federal regulators have seized three banks and one credit union, including Barnes Bank just 10 days ago. All had gambled on speculative real estate construction and land loans.
The seizure of even one more bank could further deprive cash-hungry businesses of money, potentially amplifying the credit crunch and retarding Utah's economic recovery. Community banks focus much of their lending on small businesses, which generate most jobs. Already the nine troubled banks have cut their loan volumes by an average of 16 percent, according to figures from the Federal Deposit Insurance Corp.
The banks operate in the formerly sizzling real estate markets along the Wasatch Front and in St. George. Until real estate began to slide in 2007, they were profitable; the loans produced rivers of cash. At times, construction and development loans constituted more than 70 percent of some portfolios.
They "were caught up in the land-rush mentality," said Brighton Bank President Howard Holt, whose Salt Lake City institution remained above the fray as a frenzy of imprudence and greed swept through the real estate and financial markets.
"Contractors were out there furiously buying up tracts of land, which just kept driving prices higher and higher. Some financial institutions, including their presidents and their boards, felt that, 'If we want to grow, now is the time. We need to ride the crest of this wave.' "
Mark of turmoil » Today, with real estate values off as much as 50 percent in some areas, the nine banks -- two in St. George (SunFirst and Village Bank) and one each in Gunnison (Gunnison Valley), Ogden (Centennial), Orem (Western Community), Provo (Capital Community), Salt Lake City (First Utah), Holladay (Holladay Bank) and Woods Cross (Prime Alliance) -- are floundering. As of Sept. 30, all had lost money, and all had "troubled asset ratios" that exceeded 100 percent, meaning they had more sour loans than money put aside to cover possible losses, according to American University in Washington, D.C., which analyzed the nation's banks using FDIC data.
The troubled asset ratio isn't a definitive predictor of failure, but it is a mark of turmoil, said Wendell Cochran, senior editor at the university's Investigative Reporting Workshop.
"Of the 140 banks that failed [in the U.S.] last year, 125 had ratios of over 100. It's a pretty decent indicator of stress," Cochran said.
To be sure, most community banks are not in trouble. Many have troubled asset ratios closer to the national median of 14 percent. Cache Valley Bank in Logan had a 4.2 percent ratio of troubled assets to capital and reserves. Provo's Bonneville Bank had a ratio of 4.1 on Sept. 30.
Other factors led the nine Utah banks to the brink, from heavy reliance on so-called brokered deposits to hubris by inexperienced bank managers to regulators who pushed banks to forecast future loan losses based on past losses. Because real estate loans had always performed well, some bankers believed they would need virtually no reserves in real estate.
"We've lent millions to contractors and individuals to put families in homes. We had a total loss of less than $20,000 since 1993," said Harley Jacobs, president of Provo's Capital Community Bank, one of a handful of executives from the troubled banks who would speak on the record. One-fourth of the lender's real estate, construction and land-development loans were in danger of being written off as of Sept. 30.
"If we had been able to turn the clock back and repeat what we did through 2007, I don't think we would have done anything different. And we still feel we [did] things right," said Jacobs, who thinks his bank will survive.
Douglas Christensen, president of Bonneville Bank, which has weathered the bank crisis well, said inexperience was also a factor. He is 60. Like him, anyone running a bank in the 1970s and 1980s, when stagflation gripped the economy and the savings and loan industry imploded, looked on the real estate bubble with caution.
"We were a little leery of why the market was so high and what was driving it," Christensen said. "It felt like the market was dependent on easy money. It was getting away from the loans we like to do."
Throwing caution aside » With 90 percent of its loans in real estate, Barnes Bank had been in danger of collapse for months before its recent seizure. The Kaysville-based bank survived two world wars, the Great Depression and numerous recessions in its 119-year history. But on Sept. 30, with more than a third of its loans past due, its troubled asset ratio stood at 278 percent, 20 times the U.S. median.
Earlier this month, the Federal Reserve gave Barnes five days to increase its capital reserves or find a buyer. When it couldn't, the plug was pulled by the FDIC, which insures deposits up to $250,000.
Barnes officials haven't explained why they threw caution aside. But, according to the FDIC, the bank doubled its exposure to real estate between 2003 and 2007, from $303 million to $705 million.
That wouldn't have been a problem if borrowers could have repaid their loans. Instead, as land and home prices plummeted, unemployment increased, Utah's economy sank into its worst recession since the 1930s and defaults shot up. Forty-six percent of Barnes' construction and land-development loans were delinquent, according to FDIC figures.
"For at least five years, that was the most sought-after product by customers, and obviously the most profitable. When things are good, everybody expects things to stay good," said Larry Grant, senior lending officer at Ogden's Centennial Bank, one of Utah's troubled nine.
But in September 2007 -- Grant said that was the turning point for the bank -- the bottom fell out of the real estate market, and it hasn't recovered. As of Sept. 30, Centennial's troubled asset ratio had soared to 338 --- worst of all Utah banks.
"We've not had just a recession. We've had a huge downturn that extended outward for an extended period of time, longer than anyone anticipated," he said.
Centennial could be one of the fortunate banks, despite its distress. In September, the bank announced Orem-based Vision Bankcard would acquire controlling interest and infuse new capital, though the deal hasn't closed. The acquisition was revealed three months after the FDIC ordered Centennial to make changes, when regulators said Centennial had too many poor-quality loans and was operating "with inadequate provisions for liquidity."
Liquidity is a bank's ability to convert assets to cash to meet large volumes of unexpected withdrawals by depositors without causing damage to its finances that is impossible to repair.
In hindsight, the risk to Centennial from its ballooning exposure to real estate loans should have been obvious, Grant said. But as the bank looked at the marketplace and what its peers were doing, it was hard to pass up a good thing.
'Hot money' » Banks took enormous risks during the real estate boom, often granting loans without demanding proof of income. Others used brokered deposits to fund loans to home builders and developers.
Brokered deposits are raised by brokers who earn fees by selling certificates of deposit that pay high rates of interest to investors, often via the Internet. Amounts raised from each investor are usually slightly below $100,000 so that all interest and principal are covered by FDIC insurance. The funds are often used to make risky real estate loans.
Bankers sometimes call brokered deposits "hot money." Because the deposits aren't raised locally, they aren't loyal to banks that have them. As soon as a bank has a problem or can't match a higher rate, the deposit goes away, leaving the lender holding loans that aren't backed by sufficient capital. In a sense, the bank is upside-down.
Most of Utah's nine most troubled banks used brokered deposits in varying degrees, according to the FDIC. Tiny Gunnison Valley leaned on them enough to catch regulators' attention. In September, the FDIC ordered the Sanpete County bank to stop the practice.
"When the bottom fell out, people just walked away from their houses because they weren't worth what they were costing them," bank President Paul Andersen said, declining further comment.
Virtually all of the deposits of MagnetBank were brokered just four months before the FDIC closed the Salt Lake City lender last January. The bank had amassed $282.2 million in brokered deposits; its total deposits were $282.6 million.
Most were used to make real estate loans. It had $234.8 million in loans on its books. Eighty percent were in construction and land development.
In retrospect, MagnetBank's portfolio of loans looks like a prescription for disaster. Even so, the Utah Department of Financial Institutions allowed MagnetBank in 2007 to convert its operations to commercial lending and continue to fund itself with brokered deposits. At the time, MagnetBank had shown it was able to manage brokered funding appropriately, Tom Bay, supervisor of banks for the department, told the financial services newspaper American Banker .
Today, Bay declines to second-guess the department's decision to allow Magnet Bank to convert. He said the bank failed because of bad loans, not because its deposits were brokered.
Darryle Rude, supervisor of industrial banks at the department, is more philosophical. "In retrospect, would we approve that type of business plan today? Well, obviously in today's environment that would be a poor decision. But at the time it appeared to be a good plan."
Time to reflect » Some bankers appear chastened by their behavior. Others, such as Capital Community's Jacobs, wonder how real estate lending spun so far out of control.
"A lot of what this bank's focus was, and many of the community banks share this same position in the market, is we have been relegated to a construction lending platform. We have lost our competitiveness in many of the consumer areas we don't enjoy and others do," Jacobs said, referring to credit unions, which use their federal tax exemption to offer higher interest rates.
Credit union officials counter that they provide competition that helps drive bank rates and fees lower. Unlike banks, they also have severe restrictions on raising capital to fund their growth.
Grant, the senior lending officer at Centennial, said his bank has learned it can't just make real estate loans. It also must investigate applicants more wisely.
"We have learned to diversify. We have learned to look beyond the value of collateral and to focus on the ability of borrowers to support their debt even in bad times."
First Utah, Salt Lake City
Holladay Bank and Trust, Holladay
SunFirst , St. George
Village Bank, St, George
Gunnison Valley, Gunnison
Western Community, Orem
Capital Community, Provo
Prime Alliance, Woods Cross
Source: American University School of Communication Investigative Reporting Workshop, FDIC data