Twin Cities banks are struggling with business loans gone sour. Only Michigan and Wisconsin have more of them.
A growing number of Twin Cities businesses are giving up trying to repay the debts they owe local banks on development projects.
The area's banks face the highest level of unpaid loans in years on commercial construction, multifamily projects and transforming of raw land into homes for factories, offices or retail centers, according to a Star Tribune analysis of reports made by the banks to federal regulators for the past seven years.
Although most of about 120 Twin Cities banks in the reports escaped the trend, the number mired in a business-loan muddle rose rapidly in the past year, as did the dollars involved.
For instance, the share of unpaid loans on business construction and development loans was four times higher in the third quarter of 2007 than in the same period of 2006. Unpaid loans also are four times higher than they were in the third quarter of 2001, a recession year.
In the same category, 19 Twin Cities banks in the third quarter of last year reported 10 percent or more of their outstanding loans were classified as "non-accruals" -- loans they no longer expect to be repaid.
A year earlier, only five banks had that level of unpaid loans.
Twin Cities-area banks hover near the top of the list of lenders nationwide reporting business borrowers as slow-pays or no-pays, according to the Federal Deposit Insurance Corp. (FDIC).
"Typically, construction loans shouldn't be past due," said Rich Gilloffo, a regional manager at the FDIC's Chicago office. Banks often require borrowers to take out more than they need for a project, creating reserves to keep payments current in case borrowers encounter financial setbacks.
"When you see [nonpayment rates] go up, they've run out of reserves," Gilloffo said. "Are we concerned? Yeah."
State regulators also are monitoring the situation.
"We've seen increases in overdue loans, of all types, over the last couple of years," said Kevin Murphy, a Minnesota Department of Commerce deputy commissioner. "A lot of community banks tend to specialize in commercial real estate in one form or another.''
In the top 20
A recent FDIC survey of 204 U.S. metropolitan areas found only 16 with higher rates of troubled business loans than the Twin Cities.
"There aren't too many metropolitan areas that are worse," Gilloffo said. "What's happened has happened rather quickly."
If the rankings are done by state, Minnesota banks rank even higher in troubled loans, the FDIC found. Only Michigan and Wisconsin posted higher median rates of overdue loans in the third quarter of 2007. Minnesota's median rate was nearly 80 percent higher than the national rate.
For three quarters in a row, Key Community Bank, based in Inver Grove Heights, has led the list of Twin Cities lenders with construction and development loans in the "non-accrual" category. In the third quarter, nearly 68 percent of the bank's construction and development loans were labeled as unlikely to be repaid.
That came to $4.3 million of Key Community's $6.4 million in loans. In the same period, the bank charged off $262,000 in loans. A bank official said the downturn in the housing market has spread to rental properties.
Loans showing weakness "were loans where the stated or actual purpose of the loan was for an investment involving construction or renovation of one- to four-family real estate," said David Bjerknes, Key Community senior vice president. "In other words, the borrower intended to rent out or sell the property after construction or renovation was completed."
Key Community responded, starting in 2006, by pulling back on lending in troubled categories. For instance, in the third quarter of 2007, Key Community had $6.7 million in outstanding construction and development loans. A year earlier, the total was $19.9 million.
Not as bad as it looks
Mark Saliterman, chairman of Vision Bank in St. Louis Park, said accounting rules require banks to classify loans as unlikely to be paid when payments are more than 90 days past due. That doesn't mean the banks will end up writing off all or even most of the debt, he said.
For instance, one Vision Bank business client is months behind on a $700,000 loan. But the owner has a $5.5 million offer on the property and Vision bank is first in line for repayment when the deal goes through, Saliterman said. In the third quarter, 29 percent of Vision Bank's construction and development loans were listed as unlikely to be repaid. That $700,000 loan is among the $1.6 million in that category.
"We're in the best shape that I could hope for," Saliterman said. "The reason that we're in great shape is that about a year ago, we started working on these problem loans. Many banks are just starting to work on their problem."
First National Bank of Elk River, with 27 percent of its construction and development loans labeled as "non-accrual," also is not worried about ending up stuck with large unpaid debts, said the bank's president, Pat Dwyer.
In the third quarter, $5.3 million of the bank's $20 million in loans were marked as unlikely to be paid, but Dwyer said the bank is making progress on collecting on those debts. One large debt was cleared after the borrower sold his property last week.
"It will take 55 percent of the non-accruals off the books," Dwyer said. "We could have foreclosed on this quite a while back. But everybody would have lost on that, the borrowers and all of the [contractors, subcontractors and materials suppliers]."
A limit to waiting
Nevertheless, some longtime observers of the real estate market are skeptical about whether banks can, as a rule, afford to wait many more quarters before they're forced to charge off big commercial real estate loans.
"The developers will take the hit, the consumers will take a hit, Minnesota will take a hit and the banks will take a hit," said Wade Abed, chief executive of Northwest Mortgage Co. and former president of the Minnesota Brokerage Association.
"These wonderful folks at the bank, who believe they're collateralized, they're probably as worried about making it through this period as anyone. But they're not saying so."
The boom-bust cycle is affecting business and residential real estate, said George Karvel, a real estate professor at the University of St. Thomas.
"Our ability to forecast demand is so poor that we tend to facilitate overbuilding by making too many loans," Karvel said. As real estate values plummet, banks may end up getting paid dimes on the dollar for some of their commercial real estate loans, he said.
But the pullback likely will sow the seeds of a real estate recovery in the next year or two, said David Vang, chairman of the University of St. Thomas finance department.
"A lot of projects are being stopped in their infancy," he said. "By the time the projects in process are done, the market may have recovered."
Mike Meyers • 612-673-1746