Construction and Development Loan Exposure Continues to Plague Community Banks

NEW YORK (TheStreet) -- The number of FDIC-insured financial institutions continues to decline and at the end of the third quarter the total is down to 7,181 from 7,245 sequentially. Among the total are 1,131 publicly-traded money center banks, regional banks and community banks including savings and loan associations.

Today I focus on 24 regional and community banks and their exposures to commercial real estate loans, which include construction and development loans. But first, here's a review of the regulatory guidelines for risk exposures for these types of real estate loans.

In the fall of 2005, the Federal Reserve, U.S.Treasury and the Federal Deposit Insurance Corporation realized that community banks were loaning funds to the housing and real estate markets at a pace above what these regulators thought as prudent. Guidelines were set and monitored via quarterly filings to the FDIC. These guidelines were formalized by the end of 2006. They included the following stipulations:

The guidelines for exposure to construction and development states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loans concentrations above prudent risk levels, and should have heightened risk management practices.

The guidelines for exposure to construction and development loans plus loans secured by multifamily and commercial properties are 300% or more of total risk capital, the institution would be considered to have CRE concentrations above prudent levels, and should employ heightened risk management practices.

In my opinion, one of the reasons for the great credit crunch was that the three regulators ignored these regulatory guidelines. Today 1,784 FDIC-insured financial institutions or 24.8% of the banking system remain overexposed to CRE loans.

Another measure of risk is the CRE loan pipeline. The industry considers a pipeline where 60% of loan commitments are funded as healthy. When real estate loans are paid down, new loan commitments can be made. Today 2,472 banks (34.4%) have 80% to 100% of their CRE loans fully funded, which is a reason that community banks are reluctant to lend to developers and home builders. This remains a sign that the great credit crunch continues. Banks can't issue new loan commitments until the old ones are paid off.

Among the 1,131 publicly-traded FDIC-insured financial institutions 472 banks (41.7%) have overexposures to C&D and/or CRE loans, and 317 banks (28.0%) have 80% to 100% of their CRE loans fully funded.

To compare the FDIC data of the third quarter to that of the second quarter use this link to my post of Sept. 6, Community Banks Still Under Stress. Also check out my post of Nov. 5, Book Profits on These Community Bank Stocks Now.

At www.ValuEngine.com we show the finance sector 9.1% overvalued with industry valuations that are quite divergent from region to region. Community banks in the Northeast are 19.8% overvalued, in the Midwest they are 7.7% undervalued, in the Southeast they are 13.4% overvalued, in the west they are 3.1% undervalued, and in the Southwest they are 1.1% undervalued.

Here is the daily chart for the America's Community Bankers Index , which represents 385 publicly-traded community banks.

Note that ABAQ (166.49) had overbought momentum when setting its 2012 high at 176.20 on Sept. 14, the day after the FOMC announced QE3. Note also that on Nov. 16, with ABAQ 158.38, the index was oversold. Today ABAQ is overbought again with the index between its 200-day simple moving average at 165.24 and its 50-day SMA at 168.22. This week's value level is 162.20 with monthly and annual pivots at 165.15 and 166.87 with quarterly risky level at 172.74.

Chart Courtesy of Thomson/Reuters

Profiling 24 Community Banks

Reading the Table

OV/UN Valued: The stocks with a red number are undervalued by this percentage. Those with a black number are overvalued by that percentage according to ValuEngine.

VE Rating: A "1-engine" rating is a strong sell, a "2-engine" rating is a sell, a "3-engine" rating is a hold, a "4-engine" rating is a buy and a "5-engine" rating is a strong buy.

Last 12-Month Return (%): Stocks with a red number declined by that percentage over the last 12 months. Stocks with a black number increased by that percentage.

Forecast 1-Year Return: Stocks with a red number are projected to decline by that percentage over the next 12 months. Stocks with a black number in the table are projected to move higher by that percentage over the next 12 months.

12 month trailing P/E

Assets: Add three zeros to get the total number.

C&D Loans: Add three zeros for total exposures.

Cons/RB: The C&D loan exposure versus risk-based capital.

CRE/RB: The CRE loan exposure versus risk-based capital.

Pipeline: The percentage of CRE loans outstanding versus loan commitments.

Value Level: The price at which to enter a GTC limit order to buy on weakness. The letters mean; W-weekly, M-monthly, Q-quarterly, S-semiannual and A-annual.

Pivot: A level between a value level and risky level that should be a magnet during the time frame noted.

Risky Level: is the price at which to enter a GTC limit order to sell on strength.

Observations:
  • We have nine buy-rated bank stocks and 15 hold-rated stocks.
  • Twelve banks are undervalued by double-digit percentages
  • Fourteen banks have had double-digit gains over the past 12 months led by a 67.6% gain in SNV (SNV) . The only bank with a double-digit loss over the past 12 months is VLY (VLY) with a loss of 12.9%.
  • All 24 banks are projected to be higher over the next twelve months, but by lower percentage gains of just 1.1% to 13.8%, led by SNV.
  • We show that 22 of 24 banks have reasonable 12 month trailing P/E between 10.7 and 18.8. SNV has an elevated P/E at 25.7.
  • The only bank overexposed to C&D loans is TCBI (TCBI)with a ratio of 111.7%.
  • 23 of 34 banks are overexposed to CRE loans.
  • Four banks have pipelines that are more than 80% funded.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. In 1981 he formed the Government Bond Department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. capital markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy and can be reached at RSuttmeier@Gmail.com.

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