Mortgages: Smaller Banks Smell Blood

Plain-vanilla banks known for careful lending could benefit from the problems of larger, more aggressive rivals like Countrywide

by Ben Steverman

Everyone says there's a credit crisis, with defaults on risky mortgages causing banks and mortgage brokers to tighten up their lending.

So why is Mark Tryniski, chief executive of Community Bank System (CBU), a bank in upstate New York and northeast Pennsylvania with assets of $4.5 billion, actually boosting his mortgage lending? And why are many other small and midsize banks doing the same?

For years, smaller, local banks were left in the dust by huge, innovative, and fast-growing competitors. Now amid all the pain and sometimes panic in credit markets, the plain-vanilla banks see big opportunities. Investors looking for a bright spot amid the credit-market woes might turn to these banks, who may see their careful ways finally pay off.

Steering Clear of Subprime

Tryniski's bank has boosted its mortgage originations by 15% from a year ago. Community Bank System executives are developing a marketing campaign to further promote the bank's real estate lending business.

Until recently, lenders like Countrywide Financial (CFC), IndyMac Bancorp (IMB), American Home Mortgage (AHMIQ), and Accredited Home Lenders (LEND), were tough rivals and stock market favorites. They originated huge numbers of mortgages and then resold them to investors on credit markets. Small banks couldn't originate mortgages as efficiently and weren't willing to take risks on nontraditional borrowers.

While the big brokers and banks often lent to home buyers with lousy credit histories, the more conservative, traditional banks wouldn't touch subprime borrowers with a 10-foot pole.

Now, partly as a result of that risky lending, many big lenders are faltering. They're cutting back lending and a handful, including American Home, ended up in bankruptcy as many investors refuse to buy up their mortgage debt.

Squeezed Out of the Mortgage Market

The differing fates for traditional banks and their edgier rivals goes to the heart of the current credit crisis. When brokers were simply reselling mortgages on a secondary credit market, they had little incentive to think deeply about a borrower's personal situation or ability to repay. "It only mattered what statistical category" the loan fell into, Michael Englund, chief economist at Action Economics, wrote recently. Selling innovative, mortgage-backed securities to outside investors "reduced the value of actual information about risk."

When traditional banks lent money, they were more careful. They often keep a mortgage on their books, so they know they'll be on the hook if a borrower defaults.

"These companies are generally lending to people that they know," says Mark Fitzgibbon, director of research at Sandler O'Neill & Partners.

In recent years, as competition from the likes of Countrywide heated up, many small banks pulled back from mortgage lending, says Keefe, Bruyette & Woods (KBW) banking analyst Jared Shaw. With everyone offering low interest rates, mortgages were more like a commodity, and banks couldn't make enough profit on them.

Riding Out the Storm

Now with the secondary market frozen and many mortgage lenders falling by the wayside, interest rates are changing and mortgages are becoming more profitable. Customers are also seeing local banks as a more reliable lender. "Borrowers are coming to us because if we make a loan commitment, we can close the deal," Tryniski says.

Nearly the entire financial industry has been hit by worries about a growing credit crunch. Bill Sammon, director of capital markets at Howe, Barnes, Hoefer & Arnett, an investment banking firm focused on community banks, points out that banks listed on the Nasdaq exchange are down about 13% so far this year.