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Worries About Small Banks and Builders' Interest-Reserve Loans


Some of the problems that banks face in this housing downturn has to do with construction loans. This WSJ article reports on an issue with these loans that is putting pressure on many small banks. The issue is a lending practice that allows real-estate developers to delay paying construction-loan interest. The money is put aside in "interest reserves." The FDIC is concerned that this may be hiding problematic loans.

The article mentioned a few banks that the FDIC has issued cease-and-desist orders to in regards to interest reserves. Two of the ones mentioned are banks I have reported on in the past (for their CD specials). These two were Towne Bank of Arizona and Integrity Bank of Alpharetta, Georgia.

These bad bets on construction loans could cause some 150 small banks to fail in the next few years according to analysts mentioned in the article.

One indication that interest reserves may be masking loan problems is when there are big jumps in delinquent construction loans in one quarter to nonaccruing in the next. The article has several examples of this including one from ANB Financial Bank. This was the third bank that failed this year (see post).

This issue of interest reserves masking loan problems is another reason to keep under the FDIC limits even if the financials of a bank don't look too bad. Refer to my FDIC/NCUA post for information and resources related to FDIC insurance.

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Anonymous   |     |   Comment #1
In the memorandum section of bankrate.com's Safe and Sound(R) ratings, mention is made of commercial real estate and construction loans in the paragraph that discusses asset quality. One should pay attention to that.