May 8 (Bloomberg) -- Corus Bankshares Inc., Frontier Financial Corp. and W Holding Co. are among small banks in the U.S. where bad loans have grown larger than reserves, raising the possibility of writedowns, loan limits and a demand for capital that may prompt some to seek buyers.

Reserves fall short of covering nonperforming assets at 110 of 181 small-cap banks and institutions on the Russell 2500 Financial Services Index, according to first-quarter data compiled by Bloomberg. Nonperforming assets are mostly loans 90 days or more overdue.

“The reserve is the first line of defense to preserve losses before you eat into equity,” Mark Muth, an analyst for Howe Barnes Hoefer & Arnett, based in Nashville, Tennessee, said in an interview. “It’s a sign you might have to raise more capital.” Banks that have to raise more money may try to sell themselves, Muth said.

Investors want to see reserves equal to or greater than the value of a bank’s troubled assets, said B. Riley & Co.’s Andy Stapp, a Haverford, Pennsylvania-based analyst who’s been following the industry for more than 20 years.

The average value of nonperforming assets for banks in the Russell 2500 Financial Services Index is the highest in 20 years, almost doubling to $142.7 million in the first quarter from a year earlier. Average reserves for loan losses increased at a slower pace, 35 percent, to $67.4 million, according to Bloomberg data.

Corus, a Chicago-based bank that financed condominium development in markets hit by overbuilding such as Florida, may sell itself because of an increase in bad loans. The board has hired an unnamed investment bank “to enhance the stability of the company including a capital investment, sale, strategic merger or some form of restructuring,” according to a regulatory filing May 1.

$2.5 Billion in Bad Loans

Corus’s nonperforming assets rose fivefold in the first quarter to $2.5 billion. The company has reserves of $338.6 million, according to a regulatory filing. It reported a first- quarter loss of $285 million, or $5.31 a share, including a provision for credit loss of $193.3 million.

Among its troubled assets is a 765-unit condominium complex in Panama City, Florida, according to the company’s annual report.

A Corus unit obtained the property through a deed-in-lieu of foreclosure and filed for bankruptcy protection in September. In December, Corus said 700 units were unsold and it would take three to six months and $10 million to complete the project.

“Problem loans continue to grow as a result of the continuing nationwide downturn in the residential real estate market,” the May 1 filing said.

Chief Executive Officer Robert Glickman and his father, Chairman Joseph Glickman, resigned April 24, citing personal reasons, Corus said. Randy Curtis, executive vice president of retail banking, was named interim CEO and didn’t reply to e-mail and telephone messages asking for comment. Chief Financial Officer Mike Dulberg didn’t respond to three phone messages requesting comment.

Corus fell 4 cents to 37 cents at 4 p.m. in Nasdaq Stock Market composite trading. The shares have lost 95 percent in the past year.

Future Writedowns

Of the 110 companies on the Russell index with more troubled assets than reserves, 44 have earmarked less than half the amount needed to cover them, according to Bloomberg data.

Reserves that are less than nonperforming assets is an early indicator of future writedowns because of the lag between the time borrowers stop paying and when banks recognize they can’t collect, said Bain Slack, a New York-based analyst at Keefe Bruyette & Woods Inc.

“It’s not the debt that kills you, it’s the writedown of your assets,” Slack said. “When you write down your assets, you have to write down equity. As a stockholder, that’s your money.”

Among banks with the lowest ratio of reserves to bad loans is Puerto Rico-based W Holding Co. The bank is more than a year behind in its financial reports. The most recent, in March, was for the year ended Dec. 31, 2007, and showed $1.79 billion in soured assets, a sixfold increase from the prior year.

The company, owner of Westernbank Puerto Rico, the island’s second-largest commercial bank, attributed much of the increase to 12 real estate loans. The company in 2007 also charged off $92.4 million for a loan to Exton, Pennsylvania-based Inyx Inc., a specialty-pharmaceutical manufacturer that declared bankruptcy.

Reserves, which rose threefold to $277.6 million, don’t have to be as high as nonperforming loans because the latter are backed by real estate collateral, W Holding said in a regulatory filing.

W Holding hasn’t filed its 2008 reports because of time needed to restate its 2006 and 2007 results and the hiring of a new auditor, BDO Seidman LLP, according to the filing. Chief Executive Officer Frank Stipes didn’t return six calls seeking comment.

Slack has a $1 target price on W Holding, which climbed 7 cents to $21.71 in New York Stock Exchange composite trading. The shares have fallen 61 percent in the past year.

New Capital

Bad assets at Frontier Financial, an Everett, Washington- based bank, jumped 17-fold to $675.2 million in March from a year earlier, while reserves for loan losses doubled to $111.5 million, according to a first-quarter statement April 23. The bank wrote off $58 million in loans, for a net loss of $33.8 million in the period.

About three-fourths of Frontier’s soured loans went to develop lots or to build condominiums and single-family detached homes, said the bank, which targets northwestern Oregon and western Washington. The bank’s Web site lists foreclosed homes for sale, such as one with three bedrooms and 2.5 baths, for $224,990 in Tacoma, Washington.

Frontier Financial is looking for about $100 million in new capital, Chief Executive Officer Patrick Fahey said in an interview. The bank is “properly reserved” and doesn’t need to earmark an amount equal to the full value of nonperforming loans to protect against losses, he said.

“That would assume that all nonperforming loans would be a loss and they’re not,” said Fahey, who took over as CEO in December. “It doesn’t mean that $200 million to $400 million is a loss by any stretch of the imagination. We’ve got collateral, support that we won’t lose it all.”

Wells Fargo & Co. took the opposite approach in the first quarter. The second-biggest U.S. bank by market value, with $12.6 billion in nonperforming assets at the end of March, boosted its reserve to $22.8 billion, according to a statement.

Analyst Recommendations

Of seven analysts who cover Frontier Financial, five recommend selling the stock and two say hold. Frontier Financial increased 25 cents, or 17 percent, to $1.72 in Nasdaq trading. The shares have plunged 89 percent in the past year.

Banks are reluctant to increase reserves to match bad loans because they may have to raise more capital by selling stock, which dilutes the value of their shares, Slack said. Also, under accounting rules, provisions for reserves are an expense item. Such provisions can often eliminate a bank’s profit for several quarters, he said.

If the banks don’t write off bad loans, they stay on the books, limiting new lending because of capital ratios demanded by regulators, Slack said. Regulators require banks to maintain a certain amount of capital such as cash compared with their outstanding loans. The ratios vary by the size of the bank.

To contact the reporter on this story: Peter J. Brennan in Los Angeles at pbrennan3@bloomberg.net.

Last Updated: May 8, 2009 16:32 EDT