Feeling the Ripple Effects

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by Aaron Kremer

Most community banks in Virginia sat on the sidelines as other lenders offered mortgages to borrowers with poor credit histories. And most of those banks don’t have subprime mortgages on their books.  But they’re paying the price as if they had engaged in risky lending. 

That’s because shock­  waves from the big write-downs at national lenders or investment firms are reverberating throughout Virginia’s banking industry. Construction lending has slowed, as has the pace at which banks lend to home buyers, in part because of a rise in foreclosures and an overall uncertainty about the value of existing homes.  When lenders foreclose on a home, the value of the other houses in the neighborhood can diminish.  “If a rising tide raises all boats, then a falling tide — a credit contraction — affects all boats as well,” says Gregory Fairchild, a professor of business administration at
the University of Virginia Darden School of Business. 

Bank earnings are down, and the shares of some publicly traded Virginia financial institutions are getting hammered. The stock price of Arlington County-based Virginia Commerce Bank, for example, dropped 43 percent during the last nine months of 2007.

Virginia bankers say the next year or two will be turbulent for their industry.  But they predict lending will return to normal as the market accounts for subprime fallout. No one is sure when that fallout will end. Rising foreclosures have forced many subprime lenders out of business. Meanwhile, major banks and investors who purchased securities based on risky mortgages have suffered billions in losses. The credit crunch caused by the subprime crisis has threatened to tip the national economy into recession.

Virginia bankers say the subprime mess has had a psychological effect on potential borrowers. “With all the publicity out there, people who might have been thinking about buying new houses are saying they’ll wait and see,” says Charles Majors, president and CEO of American National Bank and Trust in Danville.  “We’re seeing a slowing, but it’s not drying up.”

Bank earnings are being squeezed by a shrinking interest rate spread, says Bruce Whitehurst, president of the Virginia Bankers Association. The spread generally is the difference between what banks pay in interest for deposits versus the interest they earn on loans.

The mortgage business is cyclical by nature, Whitehurst notes, adding that he expects the market to self-correct by the middle of this year.  “The loans that reset from teaser rates, that kind are gone now, so the market should take care of itself,” he says.

Subprime lending has all but ceased nationwide.  But prime borrowers, those with good credit, may have to pay more for their loans.  Virginia bankers say their loan terms are relatively unchanged, and most of them still offer so-called jumbo mortgages for amounts greater than $417,000.  But Fannie Mae, the government-backed agency that buys and insures mortgages, is tacking on a 0.25 percent fee.  Banks that sell to Fannie Mae will most likely pass that cost along to borrowers, bankers say.

Christiansburg-based First National Bank, which has 15 branches in Southwest Virginia, saw revenues from loan origination fees decline 8 percent in the third quarter compared with the same quarter in 2006.  But its president and CEO, William Heath, says it is doing better than many banks in other parts of the country.  “We feel like we’re well positioned from a liquidity perspective to be responsive to the economy and in a better position in the future to make loans when the economy turns,” he says.

These leaner times for banks follow five robust years.  Subprime borrowers boosted demand for homes and helped run up prices.  In that sense, community banks may have benefited indirectly from subprime lending because they made loans to contractors, builders and developers who built homes sold to subprime borrowers.  “I would say the last 18 months to two years of the housing boom, for lack of a better word, was supported by the availability of subprime and alternative lending,” says John Neal, president and CEO at Bowling Green-based Union Bank and Trust, which has 34 branches around Fredericksburg and Richmond and as far west as Harrisonburg. 

Virginia hasn’t seen the sort of skyrocketing number of foreclosures experienced in states such as Florida, California and Nevada. Nonetheless, the rate is rising.  The foreclosure rate for adjustable-rate subprime mortgages in Virginia was 4.21 percent at the end of the September, slightly lower that the national average of 4.78 percent, according to the Mortgage Bankers Association. By comparison, the foreclosure rate for prime adjustable rate loans in the Old Dominion was 1.07 percent. More subprime loans are set to readjust in coming years.  Nationwide, 6.5 percent of the 50 million outstanding mortgages are subprime, with 1.3 million resetting to higher rates in 2008.  Another 422,000 will reset in 2009, according to the American Bankers Association.

Not all banks are suffering equally.  Virginia Business Bank lends almost exclusively to builders and developers and keeps most loans in its portfolio.  “We’re in good shape in Central Virginia.  There’s some slowdown in the residential, sure, but it’s part of the normal business cycle to date,” says Merlin Henkel, the bank’s president and CEO.

Foreclosures at some banks around the state are actually lower than they were last year. American National Bank saw nonperforming loans decrease from 1 percent of loans to 0.5 percent.
And in all the subprime fallout, there might be a silver lining for Virginia lenders.  Some borrowers who qualified for conventional loans instead took subprime loans from out-of-state lenders.  According to a study by First American LoanPerformance (a company based in San Francisco) between 50 and 65 percent of subprime loans went to borrowers with good enough credit to qualify for conventional loans.  Some of those borrowers, the study found, even had top-notch credit.  Now that subprime lending has evaporated, and lending terms are back to normal conditions, banks might regain lost market share. 

But bankers still may have to wade through the economic woes caused by the subprime crisis. “Nobody has a crystal ball, but we feel like the economy is probably in whitewater for the next 12 to 18 months,” says Heath, the CEO of First National Bank.

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