Mainstreet Bank of Forest Lake, one of Minnesota's largest and oldest community banks, has received a cease-and-desist order from the Federal Deposit Insurance Corp., alleging "hazardous lending and lax collection practices."
Like many community banks, Mainstreet is getting stung by loans it made to developers and builders during the real estate boom, when property prices were going nowhere but up. Now, those loans are souring at an alarming rate, and banks that hold the loans are being ordered by state and federal regulators to clean up their lending practices.

The FDIC claims Mainstreet operated with policies and practices that "jeopardize the safety of its deposits." The 105-year-old bank, which has nine branches in the Twin Cities area, operated with an excessive level of delinquent loans and did not keep an adequate allowance for loan and lease losses, according to a 23-page order, issued Dec. 12 and made public Friday. In addition, Mainstreet's board of directors was cited for failing to adequately supervise the bank.

The FDIC ordered the bank to raise more capital and reduce its concentration of construction and land development loans. A cease-and-desist order, which usually spells out a list of corrective measures, is one of the most common enforcement actions of bank regulators. It does not mean that a bank is in danger of failing or that its deposits aren't safe.

Out of commercial real estate

A Mainstreet spokeswoman said Friday that the bank is moving quickly to address the FDIC's concerns. It has temporarily stopped making loans to real estate developers, and will focus instead on consumer and business loans.

"It's back to our core, which is community banking," said Karen Greisinger, chief marketing officer. "All of our products are still in place. We're still making loans. But we're just moving away from that segment -- commercial real estate."

Until recently, Minnesota's community banks appeared to be holding up relatively well during the economic downturn. By and large, they did not originate the exotic mortgages to risky borrowers that created much of the housing bubble and ensuing financial crisis.

However, community banks did finance local builders, developers and contractors that constructed many of the housing projects that are now struggling. And there is increasing evidence that businesses -- not just homeowners -- overpaid for properties based on income projections that have proven overly optimistic as the recession deepens.

The state Commerce Department's watch list of banks it considers in "less than satisfactory condition" has nearly doubled to 50 banks from 26 just 18 months ago. A number of those banks are at risk of possible failure, but the department has declined to identify which ones.

In Minnesota, the delinquency rate on commercial mortgages and construction loans made by state banks rose 84 percent in the third quarter of 2008 from the same quarter a year earlier, according to Foresight Analytics, a California real estate research firm.

"It was the residential housing market that burst first," said Jennifer Thompson, a financial analyst with Portales Partners. "But all these home builders borrowed from someone, and those loans are starting to crack, too."

When it comes to commercial real estate, no bank in Minnesota has been more exposed than Mainstreet. As of the third quarter, the bank had the highest concentration of commercial real estate loans as a percentage of capital of more than 400 banks in the state.

"Real estate was booming, and we were there to support the development," said Greisinger of the bank's focus on real estate. "It was a niche for us, and there was a need for it."

As of Sept. 30, an alarming 37 percent of the bank's construction and land loans were more than 30 days past due -- nearly four times the national average, according to Foresight.

About 100 Minnesota banks have more than four times their total capital in commercial real estate -- a level at which heightened scrutiny from examiners may be warranted, according to the FDIC.

Not alone

Earlier this month, Lake Country Community Bank of Morristown, about an hour south of Minneapolis, was hit with a cease-and-desist order from the state Commerce Department and ordered to clean up its balance sheet.

In November, Mainstreet appointed a new CEO, Joe Tapp, previously head of White Rock Bank of Cannon Falls. The bank has also hired a financial advisory firm and has developed a three-year business plan to diversify its loan portfolio and restore the bank's capital.

Mainstreet posted a third-quarter loss of $11.2 million after adding $10.9 million to its allowance for loan and lease losses. The bank has $483 million in assets, making it among the 30 largest in the state.

Federal regulators Friday closed three banks -- one each in Utah, Florida and Maryland -- bringing to six the total number of failures this year. None of the failed banks has been in Minnesota. There has not been a bank failure in this state since 2000, when tiny Town and Country Bank of Almelund, with assets of just $30 million, was declared insolvent.

Chris Serres • 612-673-4308