Small banks with little or no exposure to the toxic debt that crippled Wall Street have money to lend as U.S. homebuyers struggle to find credit.

Here's some good news from Bloomberg:

"By Dan Levy and Ari Levy

Jan. 23 (Bloomberg) -- Matthew Stubbs said the mortgage choice was easy when he bought his Seattle dream home: Pay less than 6 percent to locally based HomeStreet Bank, or a percentage point higher and $3,400 extra in fees to Wells Fargo & Co.

“The differences were so pronounced that there was no question when it came to the final decision,” Stubbs, 31, who closed in November on a three-bedroom house in the Beacon Hill neighborhood, near Seattle’s new light rail line and Amazon.com Inc.’s headquarters, said in an interview.

Small banks with little or no exposure to the toxic debt that crippled Wall Street have money to lend as U.S. homebuyers struggle to find credit( GOOD NEWS ). While the largest lenders retrenched in the third quarter, loan volume for institutions with less than $1 billion in assets rose 6.8 percent, according to Pacific Coast Bankers’ Bank, a San Francisco-based trade group. Barry James, chief executive officer of James Investment Research Inc. in Xenia, Ohio, says that trend will continue.( GOOD )

“There’s some real strength in these smaller institutions that didn’t get in trouble,” said James, whose $650 million Golden Rainbow Fund owns community bank shares and has beaten 99 percent of its competitors over the past five years, according to Bloomberg data. “They are picking up business.”( GOOD )

HomeStreet Bank increased its residential mortgage business by 13 percent in the third quarter from a year earlier, according to a Federal Deposit Insurance Corp. filing. Meanwhile the largest national banks, including New York-based JPMorgan Chase & Co. and Citigroup Inc. and Charlotte, North Carolina-based Bank of America Corp., curtailed mortgage lending amid the industry’s $1 trillion in credit losses and writedowns.

A Local Advantage

“No longer do nationwide lenders or investors want to just pick up business 3,000 miles away, because they’re so concerned about risk,” Guy Cecala, publisher of Inside Mortgage Finance, a Bethesda, Maryland-based newsletter, said in an interview. “That’s the real advantage a community bank has. They effectively know everybody in the neighborhood, or all their customers.”( VERY GOOD NEWS )

Stubbs, who works for the Seattle City Light public utility and has an above-average credit score of 760 in a scale developed by Fair Isaac Corp., said his first contact with Wells Fargo came in a phone call with an agent in Anchorage, Alaska. By contrast, he spoke to a HomeStreet loan officer who lives in Seattle and had also bought property in the area.

“It seemed that he understood the local housing market and knew the neighborhood, which is something that isn’t captured in the standard risk profiling( YES ),” said Stubbs, who bought the house for $340,000 with his girlfriend, a graduate student.

Mortgage Applications

In November, the month Stubbs completed his purchase, U.S. mortgage applications fell to an eight-year low as housing prices tumbled. Applications picked up in December, when lower mortgage rates encouraged homeowners to refinance. The top five lenders slashed mortgage originations by 50 percent over the course of a year, according to New York-based analyst Meredith Whitney at Oppenheimer & Co.

Countrywide Financial Corp. and Washington Mutual Inc. cut residential lending before they were purchased last year by Bank of America and JPMorgan, respectively. The same was true for Wachovia Corp., acquired by San Francisco-based Wells Fargo on Jan. 1. Even Wells Fargo, which has weathered the housing crisis better than its competitors, reported a $10 billion drop in third-quarter mortgage originations from the previous quarter.

JPMorgan originated $28.1 billion in mortgages during the fourth-quarter, a 30 percent decrease from the previous year’s period. Home equity originations dropped 83 percent from the previous year to $1.7 billion in originations.

Shares Surge

When Deborah Parsons refinanced her Topeka, Kansas, home last year, she opted against Countrywide, her mortgage company for more than a decade. Instead, Parsons turned to Capitol Federal Financial, a local bank she sees daily on her drive to work.

Parsons closed the $80,000 loan in December, and now can reach a local bank representative near her home, instead of relying on the toll free number that appeared on her Countrywide bill.

“Customer service was the biggest part and just knowing their reputation,” said Parsons, 45, who refinanced so she and her husband could buy new windows and upgrade their air and heating systems. “We see their commercials, see them on the street corners.”

Capitol Federal shares have surged 38 percent in the past year, the best performance in the 495-company Nasdaq Bank Index, while Wells Fargo, Citigroup, Bank of America and JPMorgan each have fallen by at least 40 percent.

‘Aggressive’ Banks

National banks( BANKS THAT WERE COUNTING ON GOVERNMENT GUARANTEES ) that financed the U.S. housing boom “got very aggressive,” lowering interest rates for home loans, offering adjustable-rate products to subprime borrowers and selling bundled mortgages in the secondary market, said Steve Brown, chief executive officer of Pacific Coast Bankers’ Bank, which was formed in 1997 and counts more than 200 community banks as shareholders across the U.S.

“It got so tight that community banks couldn’t stand in the space any more,” Brown said. “Now the pendulum is swinging the other way. A small banker can look a customer in the eye, shake their hand and know them better. You’re not working with models and prices set in New York.”

That’s become a familiar story to John Dicus, chief executive of Capitol Federal. The bank’s market share of single- family mortgages in Kansas City, about 60 miles from Topeka, fell to 10 percent in mid-2008 from about 20 percent five years ago, when competitors offered subprime loans to the riskiest customers and Alt-A mortgages that didn’t require proof of income, Dicus said.

No Subprime Backlash

Capitol Federal, with a default rate one-seventh the average of the top 10 U.S. banks, lost business because it wouldn’t lower its credit standards( DO YOU SEE THAT IT WASN'T MANDATORY OR MECHANICAL? ). Now it’s benefiting.

Profit for the fiscal year ended Sept. 30 jumped 58 percent and only a quarter of one percent of loans is delinquent. The lender’s market share is up to 12 percent and opportunities continue to arise, Dicus said.

“We haven’t been adversely affected through the subprime and Alt-A meltdown,” Dicus said in an interview. “The smaller banks, the ones that have been successful through this, will play a big part in bringing us out of it.”( YES )

Hudson City Bancorp., a Paramus, New Jersey-based home lender, said Jan. 21 that fourth-quarter profit climbed 60 percent, bolstered by increased mortgage originations. The stock has dropped 17 percent in the past year, compared with the 66 percent slump in the 24-member KBW Bank Index.

More Growth

“The reduced number of lenders will continue to fuel our mortgage growth,” said CEO Ronald Hermance, in a statement.

Capitol Federal and Hudson City hold most of their loans rather than sell them. Banks that sell their mortgages in the secondary market have been hurt because investors that buy bundled loans are only purchasing securities backed by the government( YES ). Those accounted for 99 percent of issuances in the first nine months of 2008, according to newsletter Inside MBS & ABS.

To reignite lending, the U.S. government has poured more than $200 billion into banks through the Troubled Asset Relief Program, a $700 billion fund approved by Congress in October.

Community Bank System Inc. opted not to apply for TARP because it had plenty of capital, the DeWitt, New York-based company said in November. Today, the bank said it boosted consumer mortgage lending by 8.7 percent in the fourth quarter from a year earlier. The stock has dropped 12 percent in the past year.

Big Banks

As smaller banks increase lending and add market share, the biggest institutions aren’t losing their dominance. Citigroup, JPMorgan, Bank of America and Wells Fargo accounted for two- thirds of U.S. mortgages last year, said Cecala of Inside Mortgage Finance.

Companies in the Nasdaq Bank Index had total loan portfolios of $1 trillion at the end of the third quarter, according to Bloomberg data. The four biggest lenders had 3.5 times that amount, led by Bank of America with $1.1 trillion, which included loans made by Countrywide and Merrill Lynch & Co.

The average market capitalization of banks in the Nasdaq group is $251 million, while the top four U.S. banks are each worth an average of $52 billion.

Still, John Koelmel says his small bank in upstate New York, First Niagara Financial Group Inc., is finding more opportunities than ever and plans to expand lending in the next two to three years.( GOOD )

Adding Customers

The shares have jumped 22 percent in the past year and the lender has added customers including small businesses, real estate firms and home owners as bigger competitors like HSBC Holdings Plc and Bank of America scale back in the region, he said.

“It’s abundantly clear to us that they’re not pulling back temporarily, they’re retrenching for the longer term,” said Koelmel, 56, from his company’s headquarters in Lockport, New York. “That’s created and translated into meaningful opportunities for us. It continues to open doors for us everyday.”( GOOD )