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Shocking the Lending Market Back to Life

By Christina P. O’Neill

New York state struggles with a $6.8 billion budget deficit while banks and their small-business and commercial customers are watching and waiting for an accord in Washington on federal regulation. Too much caution will stymie an economic rebound, experts warn. And they see that caution on both sides – lenders and borrowers.

The new normal
“If you define normal as 2004 to 2007, we’ll never get back there,” says John Barrickman, president of New Horizons Financial Group and a specialist in commercial and small-business credit risk management in the commercial and private banking industries. “Regulators will impose more stringent capital requirements on banks that will restrict lending, assuming the willingness to lend is there,” he says.
However, “that’s only one part of the puzzle. You can flood the market with liquidity, but if demand isn’t there, it’s like pushing on a string,” he says.
Demand has everything to do with the current fiscal health of an enterprise. Walter J. Mix III, managing director and bank risk management specialist at global consulting firm LECG LLC, says today’s lending climate is déjà vu all over again. He was a regulator in the early to mid-1990s at a time of great public pressure on banks to lend. “When the fact of the matter was, the balance sheets of many of the borrowers couldn’t support the cash flow necessary to finance the loans,” he says.
“On one hand, banks have regulators ensuring safety and soundness through examination process and cease and desist [orders],” he says. “This has bankers looking over their shoulders. On the other hand, they have a political mandate to make loans.”

A long time coming back
Mix says there’s economic fallout from the high unemployment in Greater Manhattan’s financial industry. Home values on Long Island and Connecticut have fallen, and Mix anticipates it will take a long time for housing and employment in the region to recover. This, in turn, affects lending across the spectrum.
Mix says his New York-based bank contacts are reporting fallout from the high unemployment in Greater Manhattan’s financial industry. Home values on Long Island and Connecticut have fallen, and Mix anticipates it will take a long time for housing and employment in the region to recover.
Paul Merski, ICBA’s senior vice president and chief economist, says the “vast majority” of community banks in New York state and nationwide have plenty of capital and liquidity, but that demand for quality loans is down due to the recession, which is “deeper, longer and more widespread” than past recessions. And 40 percent of small-business lending is backed by real estate collateral, whether in a home or a commercial building.
However, there are signs of life. The ABA testified before Congress at the beginning of March that its member bankers report that “small businesses are returning to test the market for loans, even though they may not wish to borrow at the moment. It will take time for this renewed interest to be translated into new loans made, however.” Historically, business confidence and credit levels take 13 months to return after a recession, the ABA said.

Recovery is dicey

A lot of the nation’s economic rebound in late 2009 and first quarter 2010 resulted from big businesses rebuilding their inventory, New Horizons’ Barrickman cautions. “Retailers don’t expect that to continue. Once people see job growth not occurring, without spending, businesses will quit building inventory.” He sees the real possibility of a return to recession in third quarter 2010. “If the consumer shows up to the party in the second and third quarters, if small business can get financing, the recovery will continue,” he says. “The key to recovery is whether bankers will be willing and able to step up to the plate and finance small business. If they don’t, recovery dies.”
Many borrowers survived the recession’s plunging sales by liquidating current assets to fund operating losses and make debt payments. These borrowers will have to rebuild their inventory, receivables and replace fixed assets if and when the economy rebounds. However, with the departure from the scene of small-business lenders such as CIT, and other small-business lending sources, “many will find they are not creditworthy,” Barrickman warns – and many banks won’t be willing to lend them money. “Microbusinesses will find many of their traditional funding are no longer available.”

The beginning of a new cycle
Steve Dormer is executive vice president of commercial lending and strategic planning at Provident Bank, headquartered in Montebello, with $2.9 billion in assets and 34 branches in the Hudson Valley. He likens that market area to a small-cap mutual fund – with no high concentration of any one industry or another, a diversity that is a natural protective feature. Small-businesses “are still having a hard time justifying hiring people,” he says. “The growth isn’t there yet.”
Dormer says when the bank saw the commercial real estate bubble developing three years ago, it stepped back from some deals. The telltale signs were prices getting lower as credit terms got looser, he says – the result of the market’s hunger for income and its willingness to trade away the credit premium that is deserved for taking excessive risk. When the risks begin to be realized, investors hadn’t created the income to shield them from the pending loss.
“You can never gauge the end of a business cycle, but you know when one is beginning,” he says. “At the beginning, the company or project looks to be at its worst,” but its outlook should improve as the economy does. Provident has seen the slow return of commercial real estate investors returning to the local market looking for deals – and is starting to transact some of those deals.

News from upstate
The picture is mixed in New York state. In the Rochester market area, in the state’s northwest, Genesee Regional Bank has similarly refrained from tightening up on its risk parameters, in a market that has not fully enjoyed the boom years of the past two decades and therefore escaped the bust cycle, says bank president Phil Pecora. The bank has more than $180 million and only two branches, and lends only within a 50-mile radius around Greater Rochester. The Rochester economy, once dominated by larger public companies such as Kodak and Xerox, is now stabilized by its small-business community, which he describes as “the backbone of our local economy.” That said, higher education is now a significant part of the local economy – the region’s largest employer is the University of Rochester. The Rochester Institute of Technology also serves as a presence. Pecora says the colleges and universities contribute to the economy in ways beyond adding jobs. “They have proven to be valuable resources as incubators for new business ventures in the areas of optics, photonics and other high-tech areas,” he says.
Norwich-based NBT Bank is experiencing a lower home-value loss rate in its upstate New York market area, but the high unemployment rate is affecting its small-business customers. Those customers are harder hit because they generally have less equity to fall back on in tough times, according to John Carpenter, corporate senior vice president and chief credit officer in the bank’s credit administration division. “We are seeing many of them put in a position where they have to sell personal assets to pay their debts,” he says. NBT works with these borrowers to modify their loans in an effort to get them through current economic difficulties.
Add to that the presence of market forces beyond local business’ control: the region’s dairy industry presents a lending challenge, Carpenter says, because low milk prices in 2009 “have had a very negative impact on farmers’ ability to manage cash flow for their operations.”
First Niagara Bank, based in Buffalo, will have $19.3 billion in assets when its acquisition of Harleysville National Corporation is final. Chief Credit Officer Kevin O’Bryan says loan demand “is not what we have come to expect,” but that the bank, which reported an 18 percent increase in net income for 2009, has not been adversely affected.
“There’s a ton of liquidity” in the marketplace, he says. “Banks have money to lend. We’d love for demand to be more robust – nevertheless, we try to maintain a consistent approach in good times and bad.”
And field examiners haven’t been asking for tighter criteria, either, he notes. “There’s always give and take between regulators and financial institutions. That give and take hasn’t gotten any more intense – we’re cognizant of the circumstances around us, and the concerns of examiners, but again, we try to be consistent and disciplined no matter the times or regulatory focus.” Examiners are watchful of the state of commercial real estate due to economic conditions in other parts of the nation than the Northeast, he says, but they haven’t requested that First Niagara reduce its concentration.

Money to lend
Cattaraugus County Bank, in the state’s southwestern tier, is an eight-hour drive from New York City, in a market area that President and CEO Sal Marranca describes as one of the economically poorer in the state in per capita income, unemployment and education levels. The area has historically not had big industry moving in – or out – and it did not experience a real estate boom.
CCB has $150 million in assets, a $102 million loan portfolio, and a 76 percent loan to deposit ratio, with almost 50 percent of its loans classified as commercial, to small businesses, mostly family-owned. The 108-year-old bank has seen its loan growth blossom 29 percent over the last 24 months and 10 percent over the last 12 months. If you call Marranca’s office and get his voice mail, his outgoing message mentions that the bank has money to lend. CCB lends only in its own service area, and Marranca says it did not change its underwriting standards, which he describes as “conservative,” to facilitate its loan growth.
“Our goal is to make a loan to a borrower that the borrower can repay,” he says. “We’re not trying to get the highest rate, or to make borrowers overpay. It’s relationship banking, not transactional. We are not trying to make anything up in volume. With that in mind, that’s one of the reasons our portfolio has grown well above our national peers and our community bank peers.” He does connect the dots between a lending pullback by larger banks, and the growth in CCB’s portfolio. “We have definitely filled a void,” he says.

Keep credit flowing
In testimony before Congress in March, bankers testified on behalf of the ABA calling for an increase in capital to back increased lending. “The 2009 guidance from the regulators signals a prudent but flexible approach. However, we continue to hear that the translation of the guidance to the field examiners has been missing,” the ABA testified.
On behalf of the ICBA, bankers testified to the difficulties in small-business and commercial lending in local markets, including field examiners calling for banks to reduce their commercial real estate portfolios and to write down the asset value of business loans that were still performing but on which the collateral value was impaired. They also warned that community bankers might be pushed to avoid making good loans for fear of examiner criticism, write-downs and resulting loss of income and capital.
“As the economy recovers, it’s important to keep that credit flowing,” says the ICBA’s Merski. “If we don’t allow risks to be taken to extend credit, we’re not going to have a robust economic recovery. You have to allow banks to do what they do best – assess the risk and extend loans.”                                  

Christina P. O’Neill is custom publications editor for The Warren Group, publisher of Banking New York.


Posted on Monday, April 05, 2010 (Archive on Sunday, July 04, 2010)
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