Loan Losses Hinder Bank Earnings

Last updated Saturday, August 16, 2008 5:01 PM CDT in Business

By Kim Souza
The Morning News

Banks earnings are sparse to say the least, according to banking expert John Dominick, who said 2008 will likely be a "stinker" for banks of all sizes.

Dominick, the bankers chair for the University of Arkansas and 38-year industry veteran, said bankers are sailing in uncharted waters in terms of their exposure to real estate. He said as market conditions deteriorated in recent quarters, banks were left to cover losses resulting from relaxed lending standards widely used in more profitable times.

"In Northwest Arkansas, banks are very heavily weighted in real estate loans, much more so than in other parts of the state. We have never seen this much excess supply of homes and commercial space," he said.

According to Mountdata.com, there was an 11.6 month supply of single family homes in the region through the first six months of the year. The Arvest-commissioned Skyline Report recently indicated all commercial sectors were also overbuilt in the region, including the multifamily segment.

Dominick said the $89 million in real estate already recovered by area banks could take two or three years to dispose of, given the oversupplies.

Though money is cheap for lending, the slower economy often stifles borrowing demand, and ultimately reduces a bank's net interest margin, he said.

Regional economists predict the banking sector will waddle through the real estate mess for the balance of the 2008, employing conservative management practices before seeing greener pastures by mid-2009.

Sara Kline, regional economist with Moody's economy.com predicts Northwest Arkansas will avoid extended weakness and outperform the nation in terms of job growth toward the very end of the year. She said the jobs will feed population growth and wage upticks, returning the region to moderate growth by mid-2009.

In the meantime, market watchers agree banks will be challenged to retain earnings.

Small Struggles

Nine of the surveyed banks have under $300 million in assets. This group reported net income earned of $3.34 million, down 30 percent from the $4.81 million earned a year ago.

Individually, this small community bank segment reported mixed results in the first half of the year, from Rogers-based Pinnacle Bank's $989,000 turnaround to Springdale-based Legacy National Bank's $1.15 million loss - most of which occurred in the first quarter.

Both banks were chartered less than five years ago and are among a half dozen banks to enter this market during the recent economic boom.

Don Gibson, president of Legacy National Bank, said the losses relate to problem loans made during a more profitable economic time. He said banks have reeled in growth expectations and are managing through the difficulties.

"The entire region is struggling with the weaker economy, and banks are mirror images of the communities they serve. Legacy is working through these hard times and has the capital to withstand these trying times when earnings are lean," Gibson said. Legacy reported $31.7 million in capital.

Other banks in the group that posted first-half losses are Parkway Bank and the Bank of Rogers.

Parkway reported net income losses of $42,000 in the first half of the year, albeit a $90,000 improvement over the $132,000 lost in the year-ago period.

Three banks saw profits drop in the first half of 2008.

First State Bank of Northwest Arkansas posted net income of $398,000, down 24.62 percent from the year-ago period. Bank of Gravett earned $688,000 in the last six months, down 29.32 percent from the previous year's period. Decatur State Bank's net income was 12.69 percent short of last year's profit as the bank earned $1.72 million, compared to $1.97 million a year ago.

The Bank of Arkansas and Delta Trust and Bank each reported net income gains for the first half of the year. With net income profits up more than 65 percent, the Bank of Arkansas earned $990,000, compared to $598,000 a year ago. Delta Trust and Bank earned $688,000 in the first six months, 3.76 percent more than the $500,000 net income posted a year earlier.

In The Middle

Six banks reviewed had assets ranging between $300 million and $800 million. These mid-size community banks earned a cumulative net income of $6.2 million in the first half of the year, 30 percent less than the $8.81 million reported a year ago.

Only one bank made more money in the period - Fayettville-based Signature Bank reported net income of $524,000, compared to a loss of $535,000 a year ago.

The largest loss was felt by Booneville-based First Western Bank, as net income fell 180 percent in the year-over-year period. The bank posted a net income loss of $432,000, compared to $538,000 earned a year ago.

Bank of Fayetteville's earnings shrank 30.8 percent from a year earlier, while Lonoke-based First State Bank also reported a 32.4 percent decline in earnings for the same period.

At least two quarters back, Mary Beth Brooks, CEO for the Bank of Fayetteville predicted that 2008 would be tough year.

"I would like to sleep through it, and wake up in 2009," Brooks said at the time.

The longtime profitable bank still projects moderate loan growth this year, but Brooks remains cautious as the economy's recovery struggles beyond the housing crisis.

For the six-month period, Bank of Fayetteville earned a net income of $2.2 million, compared to $3.18 million a year ago. The earnings were reduced by a $1.22 million provision made for loan losses in the second quarter.

Chambers Bank of Northwest Arkansas posted net income of $932,000, down 51.4 percent from a year ago. Community First Bank of Harrison saw its net income profits dip 10.2 percent in the first six months of the year. The bank reported net income of $1.92 million, compared to $2.14 million in the year-ago period.

Larger Banks

Two of the six largest banks reviewed, Jonesboro-based Liberty Bank of Arkansas and Fayetteville-based Arvest Bank, each saw their net income slip in the first six months of 2008, compared to a year ago.

Liberty reported a net income of $10.02 million, down 9.23 percent in the period.

Arvest Bank posted a net income totaling $46.69 million, down 5.71 percent from a year ago.

As a group the five banks - with assets of more than $1 billion - reported a healthy net income of $99.2 million, down slightly from $99.3 million earned a year earlier.

Pine Bluff-based Simmons First National and Searcy-based First Security Bank each posted double digit gains of roughly 20 percent in the year-over-year period. Simmons earned $9.49 million, up from $7.88 million a year earlier. First Security posted net income of $9.02 million, compared to $7.55 million a year ago.

Little Rock-based Metropolitan National Bank reported a net income of $6.04 million, up 5.96 percent from $5.7 million earned a year ago. Bank of the Ozarks also posted a gain of 2.38 percent in the same period, reporting net income of $18.03 million, compared to $17.61 million earned a year ago.

Loan Losses

Bank earnings in 2008 have been compromised by rising delinquent loans, to the tune of $290 million, up 98.6 percent from the year-ago period. These loans are recorded as nonaccrual, the final step before a bank charges off the debt, analysts said. That is on top of $89 million in real estate the banks have already taken back through foreclosures and deeds in lieu of payment.

Loan losses must be balanced with money set aside from net income earned. The region's banks set aside $55.73 million in loan loss provisions in the second quarter, which is money that did not flow to net earnings.

"Think of loan loss provisions as cookies in a glass container that will not open. The asset can be seen, but not touched," said Tim Yeager, finance professor at the Sam M. Walton School of Business at the University of Arkansas.

Yeager said once money is set aside it is rarely converted back to earnings. When a bank doesn't have positive earnings from which to set funds aside, loan loss provisions come directly from a bank's equity capital, he said.

As of June 30, provision balances of the combined banks total $240 million, leaving about $50 million in uncovered exposure.

Banks facing the highest uncovered exposure based on delinquent loans and corresponding provisions include: Legacy National Bank, Bank of Gravett and First Western Bank.

Legacy's bank provision balance of $3.85 million covers roughly 22 percent of the company's $17.56 million in nonaccrual loans.

As the lead lender of the Legacy Building in downtown Fayetteville, the bank hopes to see a pay day soon. The bank is set to auction the upscale condo property with outstanding loans of $18 million in the next week.

First Western and Bank of Gravett have each set aside enough provisions to cover about 34 percent of their nonaccrual loan exposure. Dominick said this range is generally acceptable with regulators, providing capital ratios exceed requirements. All three of these banks are deemed to be adequately capitalized according to government standards.

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