Thomas Venables
Reduced construction lending
Play it safe? Or take a risk and profit from someone else’s loss?
Those are the questions facing Massachusetts community banks these days, as they decide how to invest their assets in a down economy in which tighter credit standards and risk aversion have hurt some institutions even as they offer opportunity to others.
Banks seem to be ambling down a conservative path, but there’s plenty of advice out there encouraging them to blaze a riskier and more rewarding trail.
George Darling, chief executive officer of Darling Consulting Group, a Newburyport firm that advises banks on asset management, has directed his clients toward investing in mortgage securities backed by government-sponsored enterprises Fannie Mae and Freddie Mac.
Mortgage-backed securities are anathema these days to investors scared off by subprime losses. But Darling said prime-rate securities have been unfairly painted with the same broad brush.
Because of that, securities backed by conforming loans are excellent values today, he said.
In February, some of Darling’s community-bank clients purchased four- or five-year-old Fannie- and Freddie-backed securities when Swiss investment bank UBS had to sell them in order to regain capital ratios required by regulators, he said.
UBS also owned subprime securities, but no one wants to buy them in today’s market, so they had to sell the prime ones, Darling said.
Banks that bought them during the few days they were for sale are now earning returns of 5.6 percent and up, he said.
“The real key is identifying [the right securities to buy],” Darling said. Banks that can do that will get “tremendous value” for their money.
In contrast, he said he would not advise buying actual shares in Fannie or Freddie today, even though they’re government-backed, because the agencies’ loans until recently have been more risky.
Pennsylvania asset- and liability-management strategist Jim Clarke, who also counts Bay State banks among his clients, agrees that probably the best thing for banks to invest in is agency-backed securities.
Citigroup announced Friday that it would be selling some off in the next couple of years, noted Robert Segal, chief investment officer at J. William Mantz Investment Advisors in Danvers.
Residential and other loans are more difficult to make in a down real estate cycle, Clarke noted, so banks should be considering other investments.
But real estate lending has long been banks’ investment standby. Two Massachusetts banks told B&T at least three-quarters of their assets are invested in their own loans.
“We don’t have any of those mortgage-backed securities. That’s way too much risk for a community bank,” said Guy Ormsby, chief financial officer at Chicopee Savings Bank.
Eighty percent of Chicopee Savings’ $464 million in assets are invested in residential and commercial mortgages and consumer loans, Ormsby said. “That pretty much tells the story” of the bank’s priorities.
Consumer demand for those types of loans has stayed steady, he added. Chicopee Savings hasn’t seen the losses from subprime some other lenders did, he said, because the bank never offered subprime loans.
He said tightened lending standards imposed on borrowers by Fannie Mae and Freddie Mac haven’t had much effect on his bank, which keeps most of its loans in portfolio.
Thomas Venables, president and CEO of $900 million-asset Benjamin Franklin Bank in Franklin, said about three-quarters of the bank’s assets are invested in its own residential, commercial real estate, consumer and small-business loans, with the greatest concentration in commercial.
Benjamin Franklin Bank has reduced construction lending – seen as one of the riskier commercial loan categories – by not accepting new customers for the moment, Venables said. Loans are still being made to customers who have had prior relationships with the bank.
“This keeps our builders that we know well operating,” he said. “I wanted to make sure they knew we would keep lending to them.”
Benjamin Franklin has a small investment – about 5 percent of its assets – in whole loan, short-term securities backed by Fannie and Freddie, he said, but indicated the bank would not be increasing that percentage much.
“You are not paid to be a hero,” he said, explaining that the bank has little interest in an investment strategy that poses large risks.
But community banks have long relied on commercial lending, and Clarke thinks risks in that area are increasing. Banks may start avoiding some types of commercial lending, on which the outlook is mixed, he said.
Darling said he’s heard that Citizens Bank and Bank of America already have started becoming less aggressive in the commercial lending arena.
A Citizens Bank spokesman said business lending actually increased at the bank between 2006 and 2007. But Darling said some of his community-bank clients in New England now have large backlogs in their commercial lending departments due to larger banks’ current contraction in that area.
“What they have to worry about is that they don’t pick up [a loan] just because someone else has dropped it,” Darling said.
According to the Washington, D.C.-based Mortgage Bankers Association, Wall Street conduits also have drastically reduced commercial investing. In the first quarter of 2007, about $60 billion in commercial mortgage-backed securities were issued, according to MBA Senior Director of Commercial Multifamily Research Jamie Woodwell, compared to just $6 billion issued in the first quarter of this year.
Many local banks look to commercial lending for best return on investment, and continue to pay top dollar for good business loan officers.
And for those interested, opportunities in the area remain, according to Segal and Jeffrey R. Glew, director of the Boston office for The Concord Group, a real estate advisory firm.
In the next year, Glew said, The Concord Group predicts that construction of luxury condominiums, big-box retail outlets in urban areas and apartment building rehabilitations in suburbs in Greater Boston will remain solid areas for investment.
Segal said he thinks construction lending remains risky, but said lending to businesses that export goods or services overseas could be a better opportunity, since the U.S. dollar remains weak abroad.
Energy-related businesses are also good investment risks, he said.
Boston commercial mortgage broker George J. Fantini Jr., chairman and principal at Fantini & Gorga, said the current market presents a good opportunity for banks looking to jump into loans that Wall Street investors have left for the moment – if they’re willing to bend a little.
For example, he said, banks should consider partial loan guarantees instead of the full guarantees they would normally require, and offer slightly longer loan terms to commercial borrowers.
“If the local banks stand back and selectively make loans the [Wall Street] conduits would have made, but make them on terms and conditions more in keeping with the bank’s menu of products,” he said, there’s business to be had..
