Faced with low loan demand, some New Jersey banks are grabbing business -- and ignoring the risk.
JERSEY CITY -- Doug Kennedy, who oversees northern New Jersey midsize business lending for National Westminster Bancorp., recently lost a 10-year-old business relationship when a global import company opted for a loan structure offered by a money-center bank.
Mr. Kennedy had proposed a loan with stricter policies than usual because the customer's gross profit margins had been eroding for the last three years. "We tightened up the advance rate and excluded inventories" which reduced the loan amount, he said.
But a money-center bank, which he would not name, stepped in and offered a higher advance rate and included all inventories, even those in foreign locations, to come up with a bigger loan.
It's not the only time Natwest lost business to a bank willing to make what Mr. Kennedy believes are risky concessions. "The question is are you going to follow the herd?"
According to Mr. Kennedy, the answer is no.
This kind of scenario is increasingly frequent, bankers, regulators and observers of the industry say. Competition to make loans is so heady in New Jersey that banks are not only dropping prices, they are also loosening strictures in what has become a market where borrowers all but dictate terms. That may be part, if not all, of the reason loan growth has increased in the Garden State by 10%, from $56.3 billion in outstanding loans to $62.7 billion this year, according to the Federal Deposit Insurance Corp.
New Jersey banks have been slower than banks in other parts of the country at getting rid of problem loans accumulated in the 1980s. According to Ryan, Beck & Co., at yearend 1993, New Jersey banks had a ratio of nonperforming assets to total assets of 3% while the rest of the country had a scant 1.9%. During the same period, New Jersey banks reported a ratio of 5.3% of nonperforming assets to loans while the rest of the country had 3.23%. These burdened balance sheets have meant greater pressure to increase loan volume.
However, with the economy growing at a sluggish 2.5%, demand for loans has not been overwhelming. While some 90 banks in New Jersey compete for the same loans, there is added pressure from nonbank financial institutions and a large concentration of international banks that have recently muscled their way into the area.
For the past few years banks all along the East Coast have relied on lowering loan-loss provisions to show high net incomes and more stable loan portfolios. But with those provisions now at very low levels, banks can only demonstrate further strength by increasing loan volume. The result is aggressive underwriting and prices.
Bankers won't provide the details of various loan structures they or their competitors have made to specific companies. But industry observers say that after talking with bankers they increasingly hear anecdotal evidence that underwriting standards are getting looser. "They tend to respond in terms of 'we're not doing it, the others are doing it,"' says Chester B. Selsberg, executive vice president in charge of bank supervision at the New York Federal Reserve bank, which monitors Northern New Jersey banks. "My suspicion is that they're all doing it," he says.
Mr. Selsberg noted that he does not observe a complete collapse in credit standards, but rather a trend of weakening loan structures. Bankers and industry observers agree. Still, banks are glad to point to their competitors as the source of the problem.
Leslie Goodman, president and chief executive officer of First Fidelity Bank in Newark, says, these days, in more than one case his bank competed against as many as seven others for a $1 million loan. In his previous 28 years at First Fidelity, Mr. Goodman says he does not remember more than three banks ever competing for that kind of loan.
"The question was who was willing to manage the transaction without collateral? You see more of that today? Citing an example, one particular equipment leasing transaction without collateral. He says First Fidelity has not dropped its collateral requirements to acquire business, but other banks have.
National Westminster rejected $40 million worth of loans during the past year because it refused to sacrifice credit standards, says Mr. Kennedy.
But Frank Van Grofski, an executive vice president and director of corporate and commercial banking at Midlantic Bank Corp., N.J., says the problem of weak underwriting is not at a crisis point yet. "It's across the board," he says, "but it's not overwhelming ."
Passaic-based Jefferson National Bank's president and chief executive officer, Joseph Greco, said that on a number of occasions he had to loosen structures to keep customers from taking their business to larger banks. What other banks were offering "was significantly low and aggressive pricing to the point where I couldn't match it," he says about one deal. "But because the customer had a relationship with us we went halfway and we were able to keep the customer."
These days banks are willing to give loans to businesses without asking for collateral or personal guarantees, according to the Loan Pricing Corp., a New York City consulting finn that researches bank lending for the industry.
Banks are also lengthening the maturity of their loans. While in 1992 most loans ended after a three year period, banks are now willing to loan out as far as five or seven years, says Steve Miller a vice president at the Loan Pricing Corp. The average maturity increased from 47 months in 1992 to 57 last year. Also, some banks are offering "back end" loans, which allows borrowers to pay back more money towards the end of the loan's tenn rather than at the beginning.
Banks are also giving borrowers more direct access to their cash, allowing them to increase capital expenditures, make investments, and pay dividends without having to ask the bank for permission first.
In most agreements in the past, taking on debt was restricted. Today, fairly high debt limits are common, says Mr. Miller.
That's going on nationwide. But in New Jersey, banks are pricing their loans much more liberally than the rest of the nation. Smaller banks in that state say that larger institutions are going after their morn-and-pop and middle-sized business borrowers because demand is so light.
On the other hand, larger regionals claim the smaller banks are undercutting their offers. They say small banks are overdependent on lending because they don't generally have other services, like personal banking or investment products, to sell. Also, smaller banks that consider themselves takeover candidates want to boost their loan volume to increase their attractiveness to larger banks. "When I see a bad [loan] structure, I say, 'Gee, buy their stock,'" quipped Mr. Kennedy at Natwest.
However, industry observers say it doesn't yet appear that the current competition for loan volume will produce another problem asset crisis. Mr. Miller says "If loan growth doesn't continue to pick up and liquidity stays as it is now, you're going to see more '80s-style loans." But current pricing for middle-market lending and for leveraged companies are between the glory years of 1992 when banks made loans 133 basis points above London interbank offered rate to the nadir in 1989 when they made loans at 75 basis points above Libor.
Meanwhile, the banks responsible for some of the more spectacular problem loans of the 1980s have either folded or gone through management changes.
"What's different this time from the last lending rush is you've eliminated a lot of your irrational competitors," says Elizabeth Summers, an analyst at Ryan Beck.
Banks have also changed their loan selling strategies, focusing not only on loan growth but on cross-selling personal banking and financial services. Thus, the larger banks say they keep business because they can offer more than smaller banks that rely primarily on making loans. "We're growing our modest amount of market share through better relationship management," Midlantic's Mr. Van Grofski says.