The Real Deal Miami

Florida bank failures follow familiar patterns

By Alexander Britell | September 04, 2009 02:39PM

Federal Deposit Insurance Corporation remains busy, closing small regional banks as it heads toward failure. As of the end of last month, the bank regulator closed 84 banks, six of which were in Florida.

Construction loans that fueled the overbuilding boom in the southeast and southwest are catching up to these ambitious, overextended lenders, who were burned when the cost of construction materials rose and property values plummeted, leaving them with incomplete lots and unpaid debts.

The FDIC shut down three Florida banks this summer, closing First State Bank in Sarasota and Community National Bank of Sarasota County in August, and shuttering Integrity Bank in Jupiter in July.

The combination of new construction lending projects and, of course, residential mortgages, proved to be a deadly cocktail for smaller banks, already struggling to find profits in areas where the larger banks were not.

?It?s clearly real estate-related,? said Jim Sinegal, a banking analyst for Morningstar. ?A lot of the regional banks overdid it in terms of construction lending.”

Sinegal said that construction loans have higher built-in risk.

?It?s just if you?re making a loan to someone that?s living in a house, it?s a lot safe, than if you?re making a loan to build a house that has not been built yet,” he said.

Of course, for Coral Gales-based Bank United, closed by the FDIC in May, houses were the root of its trouble, Sinegal noted.

?It was residential mortgages. It was probably the same sort of thing that put down WaMu — just poorly underwriting mortgages, possibly for speculative real estate investments, or people who just couldn?t afford the homes.”

Sinegal said that it wouldn?t have been uncommon for a regional bank to have had up to 25 percent of its lending tied up in construction loans.

?Basically, over the past few years, the yield curve has flattened,? he said. ?It has hurt a lot of banks? profit, and they have been pushed out of other areas of lending by bigger banks. People were searching for extra yield, and turned to construction loans. Housing was booming, and it looked to be very profitable, but it turned out to be a very big mistake for a lot of them.?

Survivors didn?t chase these profits, but instead, stuck to the basics. But in Florida, the nature of the construction industry made these loans tough to resist.

?Construction is very much a local industry,? said Andrea Heuson, a professor of finance at the University of Miami’s school of business administration. ?The bank that is the construction lender is very heavily involved in the process. The commercial banks approve payments, handle disagreements between subs and contractor, so construction lending has been a very local business. It?s been profitable — construction loans have a nice juicy return when the process works the way you expect it to.?

The way these loans play out tends to backload the risk, meaning if projects don?t get finished, or prices fall, the banks are left in a very precarious position.

?In a lot of cases when banks make construction loans, they don?t collect the interest on the loan while the project is being constructed,? Heuson said. ?At the end of the project, there is a promise from a permanent lender to step in and pay off the loan balance, and in most cases, the construction doesn?t start until there?s a belief that there?s going to be a permanent lender out there to take out the financing when the project is complete.?

For Florida?s failed banks, and the other 78 the FDIC closed, it?s been a tough lesson, she said.

?That?s all well and good if the building?s value when it is completed is larger than the sum of the construction loan, including all accumulated interest, but if something happens to decrease the value of the building, like a market move, it can be difficult to get a permanent lender to make good on that commitment, or to arrange some kind of permanent financing that will pay off the construction loan.?