Banks ponder peak in bad loans

The credit cycle has turned.

Problem loans - those that banks don't expect to be fully repaid - are on the upswing as a percent of total assets, though still within the range of the last decade.

Some analysts are worried that the loose credit of recent years, as manifested in the subprime mortgage blow-up and frothy private equity market, worked its way from the capital markets onto bank balance sheets.

"To us that is the spot to look at" in the banking industry now, said Gerard Cassidy, an analyst with RBC Capital Markets, referring to the credit quality of loans. "Part of the problem is it was so good for so long that credit standards were thrown out the window."

How long will the downturn last?

Wall Street's subprime-mortgage problems this year have oozed out in fits and starts. The same thing could happen with bank loans, raising the possibility of a protracted period of lenders wrestling with bad loans. Many banks' recent third-quarter financial statements showed increases in nonperforming assets.

SNL Financial, Charlottesville, Va., reported that the ratio of nonperforming assets to total assets at the average bank shot up from 0.28 percent in the third quarter of 2006 to 0.47 percent in the same period this year. That is just below the 0.5 percent reached in early 1997.

"The speed at which it's shifting is indicative that the problem is larger than most people think it is," said Brian Gleason, a managing director at Phoenix Management Services, a turnaround management firm in Chadds Ford.

Kevin Blakely, chief executive of the Risk Management Association in Philadelphia, said he was not concerned. "Even though nonperformers are rising, it doesn't mean they are rising to a level that is worrisome," he said.

In the early 1990s, nonperforming assets as percentage of total assets reached the 3 percent range.

Nonperforming assets are loans that are more than 90 days behind in payments, and the bank no longer expects to receive all the principal and interest due on the loan. The category also includes foreclosed real estate.

However, nonperforming assets do not equate to big losses, Blakely said. The bank might write off part of the loan, but it usually has collateral to fall back on.

Even as they were announcing big increases in loans to borrowers who had stopped paying - linked more often than not to real estate - bank executives invariably expressed confidence that they would not lose money on the deals.

At Republic First Bancorp Inc., for example, nonperforming assets jumped to $25.48 million, or 2.45 percent of total assets, as of Sept. 30, from $10.47 million, 1.07 percent, a year ago.

Harry Madonna, the Philadelphia bank's chairman and chief executive, attributed the spike in nonperforming loans to a default on three loans to related borrowers.

He said in the company's third-quarter earnings release that the bank did not expect losses on the loans, which are collateralized by businesses and real estate, including a large waterfront property on the Jersey Shore.

At WSFS Financial Corp. in Wilmington, nonperforming assets jumped to 0.54 percent of all assets from 0.18 percent a year ago. The culprit in the third quarter of 2007 was a $10.3 million commercial loan secured by real estate.

"While delinquency and nonperforming assets have increased from unsustainably low levels of recent years, our asset quality statistics remain very favorable by historical standards," said WSFS president and chief executive officer Mark A. Turner.

In an indication that more problem loans are to come, Susquehanna Bancshares Inc. of Lititz, Pa., said it anticipated classifying a $12 million construction loan for condominiums in Maryland as nonperforming in the current quarter.

Executives said they didn't expect to lose money on the deal because the units were selling.

The great uncertainty is how long the downturn in the credit cycle will last.

Mark R. McCollom, chief financial officer at Sovereign Bancorp Inc., said in a conference call with analysts that he expected credit weakness to continue well into 2008: "I think exactly how weak it gets is exactly what we, as well as the folks who cover us, . . . are all trying to get our arms around."