Regional Banks Begin Paying Prices for Their Boomtime Expansion

Concentrating on auto loans, Sovereign offered some of the best terms around to car buyers in Arizona and eight other states far from Sovereign's home branches. "They came on like a tidal wave," says Steve Dancy, finance director at Mel Clayton Ford here. "It was a car dealer's dream." Now, two years after its expansion push, Sovereign has quit making auto loans outside the Northeast because too many borrowers fell behind on their bills. Losses on the bank's loans ballooned. In January, to conserve cash as it wrote off more bad loans, Sovereign eliminated dividend payments. On Tuesday, the bank is expected to announce a 40% drop in first-quarter earnings. Similar troubles are echoing through small and midsize banks across the U.S. In a bid to expand during the recent boom, many set up operations in unfamiliar markets or started pitching new products. Others, aiming to stave off encroachment by huge U.S. financial institutions, boosted their lending by offering easy terms or lower rates. Now the slowing economy is exposing bad timing and blunders. Big U.S. banks have received the lion's share of attention since the crisis began, due to their exposure to housing-related woes. But there's a growing sense that there's another shoe to drop: losses at smaller banks. Regional and local institutions mostly dodged the initial wave of troubles because many weren't exposed to the complex mortgage-backed securities that slammed the behemoths. As housing prices continue to erode and the economy weakens, they're taking their lumps now, too. Overall, profits at the 8,533 banks backed by the Federal Deposit Insurance Corp. dropped 84% to $5.8 billion in the fourth quarter, a 16-year low. Fewer than half of all banks posted a rise in net income for the full year. That hadn't happened since at least 1984, according to the FDIC. Despite the glum outlook, few analysts are predicting a repeat of the savings-and-loan crisis of the late 1980s and early 1990s, which led to the failure of more than 1,000 U.S. banks and cost taxpayers about $130 billion. Many of today's problems are occurring at small banks: The average asset size of the 76 financial institutions on the FDIC's "problem list" of banks getting extra regulatory scrutiny was $292 million as of Dec. 31. By comparison, Bank of America Corp., the largest U.S. bank, has $1.72 trillion in assets. Bank of America reports earnings Monday. Though delinquencies and losses have risen in many types of loans, both remain below peak levels. About 1.4% of all loans were between 30 and 90 days delinquent at the end of last year. That's the highest level since 1992 but still below 1990 and 1991, when more than 2% were delinquent, according to the FDIC. As a result, Sovereign now has 750 branches in eight states, with nearly $85 billion in assets. Its market value of about $4.4 billion is slight compared with Bank of America's $169 billion. The core of its business is traditional banking operations -- taking deposits, making loans to small businesses and pitching mortgages. Sovereign extended its best rates to buyers with credit scores above 700, say people familiar with the bank's strategy, while other banks typically started at scores of 730. (Credit scores generally range from 300 to 900.) Dealers also pitched Sovereign loans at 9% interest to some buyers with 620 credit scores; other banks would typically offer 14% rates to customers with scores of around 640, turning down those with anything lower. By the summer of 2007, Mr. Dancy says he was lining up more than 100 borrowers a month with Sovereign, compared with 40 apiece with the area's traditional lenders. "Sovereign absolutely was the lowest in terms of rates and terms," says Mr. Dancy. "I'm going to do whatever it takes to move my inventory." By year's end, Sovereign's auto-loan portfolio had grown to $7 billion, up from $4.9 billion in 2006, a rising share of its $57.8 billion in consumer and commercial loans. New markets accounted for more than half of the bank's new auto loans, as well as a majority of its losses on them. The bank wrote off $76.2 million in charges for auto loans, more than double its write-offs in 2006.