Banking Euphoria Tempered by Bad Loans - TheStreet

Banking Euphoria Tempered by Bad Loans

As bank shares rally, investors are failing to recognize a large proportion of construction loans that have soured.
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NEW YORK (TheStreet) -- Bank stocks, which have rebounded this month after dismal fourth-quarter returns, still contain outsized risks stemming from construction loans. The first signs will appear this week, when banks begin publishing fourth-quarter financial results.

A total of 15% of construction loans were considered "noncurrent" as of Sept. 30, meaning payments were past due 90 days or more or the loans had been placed in nonaccrual status because lenders didn't expect to be repaid, according to the Federal Deposit Insurance Corp. The annualized ratio of construction-loan losses for the first three quarters of last year was 4.79%, the highest for any category except

credit cards

, whose rate was about twice as high.

ranked banks by construction and land-development loan exposure, using third-quarter data provided by SNL Financial for the 50 largest banks that file financial statements with the Federal Reserve and have average daily trading volume of at least 100,000 over three months.

The eight banks listed below had the highest 2010 returns among the 20 with the greatest construction-loan exposure. With so much volatility for the group, investors need to be clear on whether they're willing to hold the shares for the long haul or try to make money on short-term moves. Extra homework and monitoring is required. All of the banks in the group are still participating in the TARP bailout, and several will need to raise more capital for that reason. Some will need additional capital to ride out expected loan losses through the later stages of the credit cycle.

Bank of America

(BAC) - Get Report


Wells Fargo

(WFC) - Get Report



(C) - Get Report

have had decent returns this year after a rough fourth quarter that featured dilutive secondary offerings to raise capital and pay back the government. The

S&P 500 Financials Index

has returned 4.2% this year (through Tuesday).

Synovus Financial

(SNV) - Get Report

has the highest concentration of assets in construction and land-development loans, and the highest ratio of nonperforming assets to total assets. The company's annualized ratio of net charge-offs (actual losses) to average loans for the first three quarters of 2009 was 5.25%, and loan-loss reserves covered 3.46% of total loans as of Sept. 30.

While the company raised $600 million in capital during the third quarter and its tier 1 leverage ratio and total risk-based capital ratios were well above the 5% and 10% required for most banks to be considered well-capitalized by regulators, third-quarter loan charge-offs totaled $497 million.

Synovus Chief Executive Officer Richard Anthony said in November he's confident the company will post a profit in 2010. Investors seem to agree with that assessment, as the shares have risen 24% this month.

Next on the list is

Whitney Holding Corp.


of New Orleans. Whitney's pace of loan losses was much lower than Synovus' during the first three quarters, with a net charge-off ratio of 2.1%. Loan-loss reserves kept ahead of this pace, covering 2.81% of total loans as of Sept. 30. Whitney raised about $218 million in common equity during the fourth quarter and owes $300 million in TARP money.

Zions Bancorp

(ZION) - Get Report

has had the strongest year-to-date run-up, with the shares jumping 25%. The company lost $1 billion during the first three quarters of 2009, and the net charge-off ratio was 2.79%, with reserves covering 3.45% of total loans as of Sept. 30.

Zions owes $1.4 billion in TARP money and has used a slow-and-steady approach in raising capital. The company's regulatory-capital ratios have continued to increase despite continuing loan losses. A feather in the bank's cap is a very strong

net interest margin

of 3.94% for the third quarter.

A fourth-quarter bloodletting is possible, not only from loan charge-offs, but from expected losses on collateralized debt obligation investments and perhaps a write-down of deferred tax assets.

Marshall & Ilsley


reported the lowest capital ratios among the listed banks as of Sept. 30. The bank lost $524 million for the first three quarters of 2009, and its charge-off ratio was 4.02%, while loan-loss reserves covered 3.07% of total loans, trailing the pace of charge-offs.

The bank owes $1.7 billion in TARP money and raised $863 million in common equity through a secondary offering in October.

Susquehanna Bancshares


is one of

five cheap bank stocks

recently featured by

. Susquehanna achieved a slight profit for the first three quarters of last year and seemed sufficiently capitalized at the end of the third quarter, especially since its net charge-off ratio was just 1.06%, modest for a commercial lender of its size in a recession. The company owes $300 million in TARP money.

-- Reported by Philip van Doorn in Jupiter, Fla.

Philip W. van Doorn joined Ratings., Inc., in February 2007. He is the senior analyst responsible for assigning financial strength ratings to banks and savings and loan institutions. He also comments on industry and regulatory trends. Mr. van Doorn has fifteen years experience, having served as a loan operations officer at Riverside National Bank in Fort Pierce, Florida, and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a Bachelor of Science in business administration from Long Island University.