Little banks shared risk, take big hit

By Paul Donsky and Russell Grantham


The Atlanta Journal-Constitution

In late 2007, a small bank in Winder made a big bet on the real estate market 2,000 miles away in the Arizona desert.

The lender, Peoples Bank, put together a $100 million loan for an Atlanta developer who planned to convert 5,600 acres of scrub brush an hour from Phoenix into a massive residential community. The loan was too big for Peoples to shoulder alone, so the bank pulled more than 60 other lenders, about half from Georgia, into a complex deal to share the business.

Not long after, though, the real estate market collapsed, sending the property into foreclosure before any homes or businesses were built. Peoples Bank is now trying to sell the property for $45.8 million — less than half the original loan amount, meaning big losses for all the banks involved.

A small-town Georgia bank being the lead lender on a major development more than half a continent away might seem far-fetched. But during the now-busted housing boom, group loans involving lenders far from hot real-estate markets were common, and the fallout from such loans is causing pain for banks both big and small.

Known as loan participations or syndicated loans, this sort of multibank lending has been done for decades, but banking experts say its use soared during the nationwide real estate bubble. The loans helped developers obtain financing to meet the seemingly endless demand for new housing, while enabling banks like Peoples to get in on the action in booming big-city markets.

But as a growing number of such loans have soured amid the worst economic slump in generations, loan participations have come under intense scrutiny.

Participations have been blamed for inflating the housing boom in metro Atlanta and other fast-growing areas by making it easier for builders to obtain large loans. Losses that might have been limited to big-market lenders have been spread to small-town banks. The loans have been a factor in several Georgia bank failures, and spawned numerous lawsuits from banks that bought into failed loans, claiming a lack of proper oversight by lead lenders.

Widespread fallout

There’s no single entity that keeps track of the number of loan participations. But they were routinely used before the economic downturn, and the problems they’ve caused run deep, said John Kline, a bank consultant based in Decatur.

“There’s just been a very sour experience among many banks that bought loan participations,” he said. “There are actually banks whose entire troubled loan portfolio consists of loan participations that were purchased from other banks.”

Atlanta-based Silverton Bank, the state’s leading broker of participations, failed earlier this year amid mounting losses tied to participation deals that soured. Macon-based Security Bank, another big player, has largely shut down its subsidiary that did loan participations. A third player, FirstBank Financial Services in McDonough, failed in February.

The troubled group loans have added to many banks’ losses, and could ultimately affect the Federal Deposit Insurance Corp., which would have to cover customers’ deposits up to $250,000 at any banks that fail.

Several banks have brought lawsuits against the institutions that put the loan participations together, alleging that they poorly monitored borrowers and didn’t deal fairly with partner banks.

The mess has given loan participations such a bad reputation in the industry that most banks have sworn off taking part in any deals, experts say.

“You could see us getting back to some real ‘plain vanilla’ banking,” said Dan Blanton, president and CEO of Georgia Bank & Trust in Augusta, and chairman of the American Bankers Association’s community bankers council. “If [a loan] is too big for you to handle,” you’re just not going to do it, he said.

‘Not an ugly word’

Still, Blanton and others defend loan participations, saying they can be successful if approached properly. “A participation is not an ugly word,” he said.

Blanton said that until the economic slump dried up demand, his bank took part in about four to five participations a year without any problems. The key, he said, is for banks to carefully scrutinize loans they are considering buying into, even if they are not the bank originating the deal.

Banks have long used participations as a way to share the risk of a single loan and to diversify their portfolios so they have investments in other geographic areas.

“There’s nothing wrong with a bank in some sleepy” town with excess capital to spend “participating in the activity of a growing, vibrant market,” he said.

That’s what Peoples Bank of Winder was banking on when it sought to provide a loan to Atlanta businessman W. Harrison Merrill, the developer of the Phoenix project called Merrill Ranch.

The $100 million deal was too large for Peoples to handle alone; at the time, the small bank’s entire loan portfolio was less than $300 million. So Peoples called in Atlanta-based Silverton to help market the loan to other banks. In the end, 66 other banks signed on for a piece of the deal.

Christopher Maddox, president and CEO of Peoples Bank, said his bank carefully analyzed the Merrill Ranch plans before making the loan. The project had tremendous potential, he said, but fell victim to the global economic meltdown.

“With hindsight, everything is clear, but at that point it was a great loan,” he said. The loan was “well-collateralized, the [borrower] had money to pay.”

Loans under-examined

What went wrong with participations?

Experts say too many of the recent loan-sharing arrangements involved real estate construction and development, a market that turned out to be wildly overheated.

At the same time, some banks didn’t thoroughly vet borrowers before joining the syndicates. Banks that joined group loans often were forced to evaluate projects far from their home turf, a difficult task for some small, community banks.

“Nobody was being malicious,” said Walt Moeling, a banking attorney at Brian Cave Powell Goldstein in Atlanta. “It was just sloppy.”

He said some lead banks in the deals fell behind on paperwork and administrative tasks, leading to complaints from partners that they weren’t told of problem loans soon enough. Some partner banks also felt powerless when lead banks renegotiated problem loans, he said.

Some banks are “saying they won’t do another participation as long as they live,” said Moeling. “I haven’t heard anybody say, ‘Thank God I bought those participations.’ “

The loan participation business isn’t likely to get rolling again for perhaps years anyway, because the main players are in trouble and there’s little money available.

Silverton Bank, which had more than 500 participation loans on its books totaling almost $1.4 billion, was seized by the federal regulators in May. The so-called “bankers bank,” which didn’t take deposits from the public, had in recent years significantly expanded its loan participation business, which allowed it to take a cut from brokering the loan deals to its 1,400 client banks, including many in Georgia.

The Federal Deposit Insurance Corp., which regulates most banks, recently said it would begin selling off participation loans at Silverton and other failed banks. Many bankers who participated in the deals fear the loans will be dumped at fire-sale prices, leaving them with sizable losses.

Regulators “have this upper hand, they resolve the loan as they see fit,” said Kline, the Decatur bank consultant. “That’s just a nightmare for many of these small banks.”

Meanwhile, Security Bank has largely shut down its Fairfield Financial Services arm, which also pulled together loan participation deals. The bank, which recorded about $85 million in charges for loan losses or other problems at the unit, has been ordered by federal and state regulators to boost capital and improve its risk controls.

‘An uphill climb’

Several lawsuits have been filed and more are likely coming, said Boyd Newton, an Atlanta attorney who has represented financial institutions in two such lawsuits. “There’s not a lot of participation/syndication law out there,” he said. “The way things are going, the law is really going to develop.”

Several banks have sued Fairfield in federal or state courts, alleging it botched its management of the deals or treated them unfairly. Most of the banks demanded to be repaid for their portions of the loans after the borrowers defaulted.

Lawyers disagree on whether aggrieved banks will have much success with those lawsuits.

Such lawsuits “are a real uphill climb for the participating banks,” said Newton, because each of the partner banks was responsible for checking out the borrower — a process called due diligence — as though it was the sole lender.

“In the future I think the participating banks are going to make sure they’ve completed the due diligence before they enter into one of these syndicated loans,” Newton said.

But Rob Williamson, another Atlanta attorney who has represented banks in some of the lawsuits, said it was not unusual for some small banks to join the deals partly because they trusted the larger lead bank’s own due diligence. “Some of these banks do not have a large commercial underwriting staff,” he said.

Either way, he added, most banks big and small failed to see the coming end of the real estate bubble.

“When you have a collapse like that ... I’m not sure there’s much you can do about it,” he said.

How we got the story

This article was based on interviews with lawyers, bankers and real estate agents familiar with loan participations or the defunct Arizona development financed by Peoples Bank’s loan participation deal. We reviewed lawsuits filed against lead institutions in other loan participation deals and the loan agreements themselves. We reviewed real estates sales material for the development in Arizona, marketing material for Silverton Bank’s loan participation services, and Federal Deposit Insurance Corp. documents related to the wind-down and sale of loan participations at Silverton and other institutions.