Hampton Roads banks start to feel the pain of bad loans

NORFOLK

When Commonwealth Bankshares Inc. reported its earnings for the July-through-September quarter two weeks ago, it called attention to its greater size. The Norfolk-based parent of Bank of the Commonwealth noted that its assets had surpassed $1 billion.

But the figures that attracted the attention of bankers and investors had to do with Commonwealth's third-quarter loss and a surge in the volume of its troubled loans. After adding $20 million to its reserves for loan losses, Commonwealth reported a $9 million loss for the quarter.

Its non-performing assets - a combination of problem loans and repossessed real estate - swelled to $33 million from $5 million a year earlier.

The sudden deterioration in asset quality at Commonwealth comes after years of subdued levels of troubled loans at community banks throughout Hampton Roads. Commonwealth's need to bolster its reserves calls attention to the effects that a slower economy and faltering real estate markets may be having on all community banks - those with assets of $1 billion or less.

For community banks in Hampton Roads, the level of troubled loans and repossessed real estate at the end of September still compared favorably with figures for their peers elsewhere and with banks of all sizes nationwide, according to SNL Financial, a Charlottesville-based publisher of financial data. The local banks' non-performing assets stood at an average of 0.59 percent of their total assets, according to SNL. That was well below the 1.49 percent average for community banks nationwide and the 1.51 percent average for all banks, according to SNL.

However, the region's two dozen or so community banks are likely to report rising levels of troubled assets in coming quarters. That's partly because many of these banks rely more heavily on lending for construction and real estate development than much larger institutions.

"Asset quality is the No. 1 issue that everyone will be facing for the next 12 to 24 months," said Bob Aston, chairman and chief executive officer of Portsmouth-based TowneBank. "The obvious problem that all of us have to confront is the continuing weakness in the economy."

TowneBank, the largest bank based in Hampton Roads, reported that its non-performing assets at the end of September were 0.09 percent of total assets. That was down from an already modest 0.1 percent a year earlier.

"Non-performing assets are creeping into all banks' portfolios" but are especially noticeable at institutions that concentrate on construction lending, said David Danielson, president of Danielson Associates Inc., a Vienna, Va.-based bank consulting firm.

Whether they do business throughout the country or serve a single metro area, banks routinely have to deal with troubled loans. But these loans can become costly and even threaten a bank's health. That's because financial institutions must set aside reserves to cover potential loan losses and still must pay interest on the deposits that support their sour loans. In addition, significant amounts of management time and outside resources, including legal help, may be needed to work out problem loans and protect the collateral.

As the economy loses steam, the real estate that banks hold as collateral is likely to lose value, making it more difficult to recover their troubled loans.

Joe Face, Virginia's commissioner of financial institutions, said the state Bureau of Financial Institutions has been monitoring the levels of non-performing assets at state-chartered banks more closely in light of the faltering economy. For the most part, community banks in Hampton Roads and elsewhere in the state are stronger than their counterparts nationwide, he said.

"We have bankers and banks that have been through these types of cycles before," Face said. And rather than hunting for lending opportunities in regions such as Florida, Atlanta and Las Vegas that appeared attractive earlier in the decade, Virginia's community banks stuck to their own markets, he said.

Commonwealth's non-performing assets at the end of September jumped to 3.2 percent of its total assets from 0.62 percent a year earlier.

Face declined to disclose at what point state regulators consider an institution's non-performing assets worrisome or to say anything about regulators' scrutiny of particular community banks. The state's regulators, he said, weigh an institution's non-performing assets with several other indicators, including the amount of its capital. That's because "capital will enable a financial institution to weather storms, sometimes for extended periods," Face said.

Edward Woodard, chairman, president and chief executive officer of Bank of the Commonwealth and parent Commonwealth Bankshares, blamed the surge in his bank's troubled loans on the deteriorating economy and particularly on weakness in the real estate sector. Having any non-performing assets is a concern for Commonwealth, and the bank's goal "is to keep them as low as possible," Woodard said.

However, Commonwealth's $9 million loss for the recent quarter hasn't prompted any changes, and the bank has more than enough capital to meet the top tier of regulatory requirements, Woodard said. If needed, it can draw on $20 million of additional capital from its parent, he said.

"We're not making loans any differently than we have for the last 37 years," Woodard said.

But the environment in Hampton Roads for all banks is likely to worsen before it improves, and that could spur another round of consolidation. Much like it did in the early 1990s, an increase in the number of institutions with troubled loans, weak earnings and capital problems will prompt a string of mergers, bank consultant Danielson said.

Tom Shean, (757) 446-2379, tom.shean@pilotonline.com