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Commercial loans tighten up -- a bit
By Jay MacDonald
Bankrate.com
The days of relatively easy money from commercial
lenders look like they're ending -- and that could mean fewer choices
for small-business owners seeking capital.
Big-picture economic concerns are starting to
filter down to the little guy, as lenders begin to feel the pinch
from the slowing of the economy. There's no cause for alarm, but
there is a conscious effort in the commercial banking field to pull
in a bit on the reins.
The big picture
Recently, Federal Reserve regulators put America's
commercial lenders on notice to tighten up their underwriting standards
as the economy continues its bumpy descent from the stratospheric
cruising altitudes of the past few years.
The Fed didn't like what it saw in its annual
review of syndicated bank loans -- representing loans in excess
of $20 million shared by more than three lending institutions. The
exam found that lenders had become a little too lax during the good
times between 1997 and mid-1998. As a result, adversely rated assets
grew from $45 billion in 1997 to $127 billion in 2000, reflecting
more problem loans than at any time since 1992.
The good news is, small-business lending has
so far remained unaffected by the move. That's because their loans
are generally too small (under $1 million) and well-managed to even
appear on the Fed's radar.
The bad news is, the effects of the Fed's inflation-fighting
measure may soon trickle down to small-business lenders who already
suspect they may have to make some underwriting adjustments if America's
"soft landing" continues to encounter unexpected turbulence.
'A much tougher environment'
In September, Al Sanborn, president and CEO of the Risk Management
Association (formerly Robert Morris Associates), a financial services
trade organization, sent a letter to members warning of the impending
clampdown by regulators.
"Internal risk-rating systems will be heavily
scrutinized and you need to be sure that your people understand
them and use them," he writes. "After such a long period of good
times, it would only be human if folks are a little slow to recognize
increased risk."
Sanborn said rising energy prices and a sell-off
on Wall Street could pose additional threats to already elevated
risk levels, especially in industries hardest hit by technology.
"The bank examiners in general are getting tougher,"
says Pam Martin, director of regulatory relations and communications
for RMA "They see a rising level of risk within the banking system
and they are concerned. We are in a much tougher environment."
Preemptive and prudent
measures
Keith Leggett, senior economist with the American
Bankers Association, sees the tightening of commercial credit
as a wise preemptive move by the Fed.
"It's more a reflection that there are a growing
number of businesses that are starting to have problems," he says.
"This is causing banks to pull back in some specific industries
where you're getting problems, primarily telecommunications, movie
theaters and nursing homes. We are also seeing the downturn start
to hit other industries. Clearly, there are signs that slowdowns
are beginning to occur. That will cause some excess stress."
The environment is quite different from the
last time the nation's lenders doubled up on antacids.
"In 1990-91, banks had to pull back lending
because they didn't have the resources, especially capital and loan-loss
reserves, to cover those problem loans," Leggett says. "Today, banks
are well capitalized and have ample reserves to cover long losses."
At issue is risk. Nonconforming loans and personal
bankruptcies, both up sharply, are worrisome signs to lenders.
"Because of their concern about the economy,
and because they are slightly less tolerant about risk, they are
starting to pull back a bit," Leggett says. "Banks still remain
willing to provide credit but are pricing the loans to reflect the
risk. If you're a AAA credit, you're still going to pay a very low
rate. However, if you are high risk, you're probably going to pay
a little bit more to get that loan. It's just being prudent. This
is prudent management of risk."
Safety in scorecards
Commercial lenders may wheel and deal to underwrite multi-million-dollar
syndicate loans, but when it comes down to small-business loans,
they play it close to the vest, according to Christy Schmitt, vice
president of loans for Union Bank of California.
"Most banks do their small-business lending
based on scorecards, which are based on proven credit quality factors
of the business and the individual," she says. "The scorecards are
a little more conservative just because they are scorecards. With
small business, you make a minor adjustment to the scorecard and
you don't have any heavy concentrations in any one industry or large
amounts of loans out to any one customer."
Small-business lenders also tend to steer clear
of risky "air ball" lending to dot-com companies.
"Those type of loans probably wouldn't be made
in the small-business segment because those businesses have not
turned a profit," she says. "Small-business loans are based on cash
flow and profitability, and those guys are making money or surviving
on venture capital."
Schmitt says the economic cool-down would likely
affect small business lending before any action by government regulators.
"Small businesses are a lot less tolerant of
economic downturns in general," she says. "If the economy should
start to turn, some of the credit may turn, too. It's a lot more
sensitive to the economy than the larger deals are."
"We're watching it. We're watching the portfolio.
We're watching the back-end charge-offs to see any early warning
signals. But we have not made any adjustments to date."
Let's make a deal
Paul Falvey, executive vice president of commercial lending for
First
International Bank, says borrowers already may have noticed
a different climate in their bank from a year ago. While credit
is still available, the terms may reflect a slightly more cautious
nature.
"Maybe the term of the loan, instead of five
to seven years, today would be for five years only," he says. "Maybe
a year ago, you might have gotten a little more working capital
to help grow your business. If you have a credit that three banks
were interested in doing, maybe today you have a credit with one
bank or a bank and an SBA loan program."
"I don't think small-business loans have changed
that dramatically. The credits we would have said yes to a year
ago we'd say yes to today, and the ones where we would have said
no are still a no. But some of those terms that go along with it
probably have tightened a bit."
Softening the blow
Leggett says it's easy to miss the positive side in all of this.
"Commercial loans are still going to be growing
at a fairly healthy pace," he says. "While it's not going to be
at the double-digit pace we've seen in the last three years, we
are going to see it growing at around 7 to 9 percent. That's still
a healthy rate."
A little restraint now might help prevent drastic
measures later.
"We are very deep into the largest peacetime
economic expansion in our history. One of the things you start to
get concerned about as you go along is that, at some point, the
other shoe is going to drop and there is going to be a slight downturn.
You need these periodic pullbacks to ensure that the market does
remain fairly healthy. If you have too much exuberance out there,
it may call for a major correction that will have really disruptive
effects on the economy. Too much lending now could potentially deepen
the correction later on."
Jay MacDonald is a contributing
editor based in Florida
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