Acres of empty new-home lots marked by evenly spaced power hookups lie along Camino del Toro, west of South Houghton Road in Corona de Tucson. Nearby stands a sign: "Financed by National Bank of Arizona."
In 2005, the development group Sky Island Properties Inc., led by Carl Pepper, took out a $32 million loan from National Bank of Arizona to buy land and make improvements there. Last November, the bank took the developers to court for defaulting on the loan and had the land placed under another developer's supervision, court documents said.
The story is one that's growing more common in the aftermath of the housing slump. As demand for new homes has dropped and developers are falling behind on their loans, community banks are starting to feel the sting of the slowdown.
Delinquent loans are going up on many bank balance sheets, according to data from the Federal Deposit Insurance Corp. Big banks also show increases in problem loans. But for community banks, which often focus more on small-business customers than consumers, the defaults tend be concentrated in loans made to local developers and real estate investors.
Local community bank executives say their institutions are in a strong position to handle the slowdown because they largely stayed away from the riskiest market segments, such as subprime mortgages. But others say that all financial institutions will feel some pain.
"Nobody is infallible," said Michael Hannley, president and CEO of the Bank of Tucson. "As much as I would like to be, we're not, either."
Signs of a slowdown
Community banks, including the Bank of Tucson, Commerce Bank of Arizona, Canyon Community Bank, Alliance Bank of Arizona, Bank of Arizona, National Bank of Arizona, First National Bank of Arizona and Southern Arizona Community Bank, all showed spikes in "non-current" loans — those 90 days in default — from the end of 2006 to the end of 2007, according to FDIC information. "Charge-offs," those written off the balance sheet, are also growing for most of those banks.
For example, the Tucson-based National Bank of Arizona's non-current loans rose to $75.8 million by the end of 2007, up 800 percent from $8.2 million reported at the end of 2006, according to the FDIC.
As a percentage of all loans, the delinquent loans jumped to 1.65 percent in 2007 from 0.2 percent in 2006, according to the data.
If delinquencies reach the 2 percent to 3 percent range, regulators and investors start to become concerned, said Norman Katz, a financial institutions consultant in Irvine, Calif.
National Bank of Arizona's defaulted loan percentage may be higher now. The bank's parent company, Salt Lake City-based Zions Bancorp., reported to the U.S. Securities and Exchange Commission on Thursday that its non-performing assets rose more than 50 percent in the first quarter of 2008 from the end of 2007. Zions also operates banks in Texas, California, Oregon, Washington, New Mexico, Utah and Nevada, according to the FDIC.
Dave Lyons, National Bank of Arizona's regional president, said the problem with defaults "seemed like it started last year with the residential market downturn, and it's spreading — not a lot — to some other property types."
Banks say local focus is key
Community bankers said their local focus allows them to keep a close eye on their lending, and all said their banks take a conservative approach to evaluating credit risks.
Southern Arizona Community Bank President John P. Lewis said that he personally signs off on all of his bank's loans, which he credits with keeping bad loans off his books. His bank's higher delinquency rate in 2007 was the result of just one loan, he said, and it is no longer a problem.
National Bank of Arizona has encountered some defaults by local developers, including Sky Island and Pathway Developments. But Lyons said local developers are a good market for his bank.
"Those are people we can meet and see and talk to, and if there are problems, you can sit at a table with them and discuss what's going on," he said.
Preparing for problems ahead
As loan-default rates rise, some banks are also getting more aggressive in setting aside reserves for future losses. Scottsdale-based First National Bank of Arizona bulked up its loan-loss reserves to about $50.8 million by the end of 2007 from $19.7 million at the end of 2006. Phoenix-based Alliance Bank of Arizona raised its reserves from about $5.7 million to about $6.7 million.
First National Bank, which did significant business in residential mortgages, shut down its wholesale mortgage arm last August and cut about 350 jobs. At the end of 2007, the company's delinquency percentage was 4.19 percent, according to the FDIC.
Setting aside reserves is another sign that local banks are being careful about future risks, said Tanya Wheeless, president and CEO of the Arizona Bankers Association — although some banks are still expanding.
"Certainly, they're bracing for some potential losses," she said, but added: "The bankers are optimistic that we're going to rebound."
loans written off the balance sheet
Charged-off loans Charged-off loans Dec. 31, 2007 Dec. 31, 2006
Southern Arizona Community Bank 0.09% 0.01%
National Bank of Arizona 0.30% 0.29%
Alliance Bank of Arizona 0.44% 0.01%
First National Bank of Arizona 2.13% 0.04%
Commerce Bank of Arizona 0.08% 0.08%
Bank of Tucson 0.00% 0.12%
Canyon Community Bank 0.03% 0.03%
Bank of Arizona 0.43% 0.01%