Regulators warn about inflated loan portfolios

Regulators Have Begun Warning About Inflated Loan Portfolios in a Slowing Economy

The economy is rolling along. Good times are here. Let’s lend more money.

That’s the tune many Banks were singing two years ago.

But as the smoke signals of an economic slowdown keep getting thicker and blacker, that tune is changing.

Many commercial Banks already have tightened the reins on lending, especially in their construction and commercial real estate portfolios, since losses in those areas are increasing. Federal regulators are making comments to banks, warning them of the growing portfolios.

“When you come out of a long-term growth economy, you have a situation where banks were very accommodating in underwritings and credit extensions,” said Norman Katz, a banking analyst with MCS Associates in Irvine.

Because of the hot economy, many banks have inflated loan portfolios that could take a dive when the economy slows and delinquencies and bankruptcies increase.

Bank examiners with the Federal Deposit Insurance Corp. reported more frequent occurrences of risky underwriting practices in three of the seven major loan categories in the six months ended Sept. 30 compared with the prior period: construction, commercial real estate and home equity lending.

According to Rich Brown, the chief of economic and market trends of division insurance with the FDIC, banks’ construction-loan portfolios have grown more than 20% annually for the past three years.

“There is an economic cycle and we are cycling out of a very hot growth economy into a slowing environment, with tougher business conditions, more bankruptcies expected and more failing companies. That clearly is translating into credit quality problems in the portfolios,” Katz said.

The growing number of problem loans have regulators and the industry worried. A strong economy spurred aggressive lending practices by banks in the 1980s. But as recession rolled in at the end of that decade and real estate values dropped, borrowers started defaulting on loans. Some banks failed.

“Commercial real estate and construction lending was the leading cause of failures of banks and savings and loans in the late ’80s,” said Ed Carpenter, a bank consultant with Carpenter