One of the riskiest loans a bank can make is to a speculator — an investor who borrows money to build and sell a home.
Usually, the borrower puts little of his or her own money into the deal and tries to sell the home for a higher price as soon as it is built.
Some banks figure the reward is worth the risk because these loans pay higher interest rates and generate more fees than a normal mortgage.
But when the economy sours, these loans typically are the first ones borrowers walk away from.
Riverside Bank of the Gulf Coast was steeped in them.
Regulators understood the danger and warned Riverside about it as early as 2002. Bank executives did not listen.
By April 2006, Riverside had more than 1,300 such loans, totaling $155 million. These loans would soon start to go bad.
But it was not just the type of loans made by Riverside that vexed regulators. It was the slipshod manner in which they were monitored.
"Loans are not being maintained in a cohesive order," regulators wrote in 2002
. "The loan review program has not kept pace with the growth and complexity of the loan portfolio."
In a report prepared for each failed bank in the nation, the FDIC concluded
that Riverside failed because it did not control the risks from its lending strategy.
"Speculative investors involved in ongoing residential real estate construction projects stopped making payments when property values fell below the agreed upon purchase price," the OIG wrote.
Elmer W. Tabor, a Cape Coral Realtor and former Riverside director, agreed that "stated-income" loans to speculators who "did not have to put any of their own skin in the game" is what hurt the banks all across the country. But he blamed mortgage giants Freddie Mac and Fannie Mae for accepting those loans in boom times.
When those two companies suddenly stopped buying loans in 2007, it was the beginning of the end, Tabor said. Banks had to keep the loans on their books, which forced them to raise additional money at a time when capital was hard to come by.