The war for loan growth has moved to a new battlefrontinstead of pricing, banks are now competing on loan terms.
Barely removed from years of cleaning up credit quality, lenders are conceding terms to borrowers on everything from the length of amortization to waiving cancellation fees. Competition on loan structures has emerged in the central California banking market in the past 45 days, says Robb Hemsath, president and chief executive of the $94 million-asset Security First Bank in Fresno, Calif.
"The theory is, the economy is improving, so you can take on that additional risk and be OK," Hemsath says.
In the chase for loan growth, some banks appear willing to bend on loan structures in ways that were previously taboo. During the second quarter, a competitor refinanced a First Niagara Financial Group (FNFG) customer, because the lender was willing to double the loan's leverage and waive other restrictions, Gregory Norwood, chief financial officer, told analysts during a conference call last month to discuss earnings.
"It speaks to the insane structure competition," Norwood said later in an interview, declining to name the bank that refinanced the loan. Conceding loan terms "pretty much puts all the cards on the borrowers' side of the table," he says.
Banks are seeing some expansion of their loan books, though the growth is anemic. Net loans and leases for all banks rose 3.8%, to $7.5 trillion, in the first quarter from a year earlier, according to the Federal Deposit Insurance Corp. Net loans actually fell 0.4% from the fourth quarter. The problem is more acute for the smallest banks. For commercial banks with less than $100 million of assets, net loans fell 10.6% to $59 billion from a year earlier.
"There's not enough loan demand, and there's an awful lot of money to lend," says Jeffrey Seibert, chief operating officer at the $1.2 billion-asset Orrstown Financial Services (ORRF) in Shippensburg, Pa. "The few deals up for grabs are being shopped heavily and being competed on heavily."
But chasing growth, at the expense of risk management, is a mistake, some bankers say. Both Norwood at First Niagara, and Hemsath at Security First, said they will not compromise on loan structure to win business.
"We're going to stick true to our covenants, in both good and bad markets," Hemsath says, adding that he has no plans to compromise on loan terms to win business.
Management at First Niagara is uncomfortable with competing on structure, because "you're just creating risk that you're not creating when you compete on pricing" alone, Norwood says.
Amortization length is one of the most common areas where banks are trying to compete, says Chris Marinac, an analyst at FIG Partners. Stretching out amortizations lowers the borrower's monthly payment but adds to the lender's risk. Amortizations are "lengthening to 25 years from the old-fashioned 15-year window," he says.
Some banks have recently made concessions to borrowers on debt-service coverage, too, Marinac says. Federal regulators recommend that lenders require borrowers to have an income stream that is at least 1.25 times cash flow. But that benchmark has slipped at some banks, to 1.1 times cash flow, or as low as 1 times cash flow.
Examiners have emphasized to banks the importance debt-service coverage. In a report last year, the FDIC said that debt-service coverage is a risk measure that has been used to assess commercial real estate loan repayments, and that banks should use debt-service coverage as a factor when conducting its own stress tests.
"Banks should have in place policies and procedures for the risk they are willing to assume," says Greg Hernandez, a spokesman for the FDIC.
Other areas in which Marinac has been told banks are making terms more favorable to borrowers include allowing borrowers to pay off loans early without incurring fees, and generally weakening covenants in loan documents so borrowers have little to fear in the event of default.
"When times get tough, the borrower can walk very freely," Marinac says of such loan agreements.
Competition on structure has not reached all sections of the country. Astoria Financial (AF), a $16 billion-asset thrift on Long Island, has seen little competition on loan structure.
"It's very competitive [in the New York market] on price, but nobody in this market is going crazy in terms of over-leveraging," CEO Monte Redman says.
Others say that, while some banks may be giving too many concessions to borrowers, the pendulum is simply swinging back to normal, after banks implemented tight policies during the economic crisis.
"In some cases, the terms were overly restrictive due to regulators and bankers' memories of the debacle of 2008-2011," says Rick Weiss, an analyst at Boenning & Scattergood.
Then there is the problem, Weiss says, of actually verifying the rumors that banks are budging on loan structure, without actually seeing the loan documents.
"It's always the bank down the street that sacrifices underwriting standards to get business," Weiss says. "Just once, I'd like to talk to the bank that admits it and says they're willing to take a few losses in exchange for greater volume."