Smaller U.S. banks face subprime mortgage strains

By Mary Childs

WASHINGTON, Aug 15 (Reuters) - Rising defaults on U.S. subprime mortgages have been wreaking havoc at many large banks and financial institutions, and now the same problems are leaking into the small-bank sector. Small-capitalization banks, which typically hold less than $4 billion of assets, are tightening credit like their larger counterparts, but are now getting stuck with mortgages they had hope to sell, rather than hold in their own portfolios.

Much of the recent turmoil has focused on Wall Street banks and hedge funds that dove too deeply into home loans once thought safe but which ultimately proved sour. Many borrowed heavily, hoping to generate higher returns.

Smaller banks didn't take such risks. But they're feeling the fallout.

"We're only going to do very stable credit quality loans," said Marcia Bradshaw, senior vice president of mortgage lending at Virginia Commerce Bancorp Inc. (VCBI.O), an Arlington-based bank with $2.1 billion of assets. "We're not putting anything on the books that's risky in any way."

GUN SHY

Like many smaller banks, Virginia Commerce doesn't deal in "Alt-A" mortgages, the credit class just above subprime. But like most banks, it does extend mortgages it hopes to resell to investors.

That's becoming difficult, however, as mortgage buyers steer clear. Investors who had been willing to put up cash for riskier loans -- and even some still considered safe -- have turned gun-shy. Some larger mortgage companies, like American Home Mortgage Investment Corp. (AHMIQ.PK), have gone belly-up.

Smaller banks have been left with 30-year mortgages on their books, eating into profit margins and forcing them into short-term borrowing.

"The investors we sell to -- their money, their credit has diminished," said Bruce Whitehurst, president of the Virginia Bankers Association, which provides services to 161 banks in Virginia and Maryland.

"They get most of the money from Wall Street, and if they don't have the money to fund the loans we want to sell to them, we don't have as many outlets to sell to," he added.

The lack of investor appetite means banks stuck holding older mortgages won't have capital available to make new ones. This could mean borrowers won't find loans to buy houses they can afford.

OVERREACTION

For the financially responsible couple seeking a home mortgage over $417,000 -- the "conforming" amount that government-sponsored finance companies Fannie Mae (FNM.N) or Freddie Mac (FRE.N) will buy -- a loan may be harder to find.

Retirees who want to downsize to smaller homes may also face a problem. With so-called jumbo loans harder to find, these would-be sellers may have trouble finding a buyer.