Is tax reform fueling a price war in commercial lending?
The federal tax cuts have definitely had an impact on commercial lending, just not the one that had been predicted, bank CEOs said this week in quarterly earnings calls.
A boom in commercial loan demand has not occurred, or at least not yet, as business customers move cautiously. Instead, the 2018 tax cuts may have spurred a price war as lenders offer commercial borrowers lower prices in hopes that their tax savings will make up the difference.
Bill Demchak, the CEO of PNC Financial Services Group in Pittsburgh, said that competition for commercial and industrial loans and commercial real estate loans had intensified, and he said he thinks tax reform might be the driving force.
“Certain behaviors would suggest that people are willing to cut price as a function of the after-tax [return on equity],” he said. “It's on the most generic ‘one bank can hold the whole deal’ C&I loans, which is kind of the craziest place, in my view, to start competing away price because you still have the risk associated with the loan.”
Many initially assumed a pro-business agenda in Washington would boost business confidence and with it, spending and borrowing, but bankers have had to adjust their expectations as the year has worn on.
The opening of first-quarter earnings season seemed to confirm that tax reform isn’t translating yet into a broad-based increase in business borrowing yet.
“There’s been an expectation that as a result of tax reform, there might be expansionary plans,” Wells Fargo’s chief financial officer, John Shrewsberry, told reporters Friday. “But what we’re seeing is relatively static utilization of committed lines and a pretty modest level of growth overall.”
Bryan Jordan, CEO of First Horizon National in Memphis, said that while commercial customers were optimistic about the economy, they seem for now to be spending their tax savings on other things than new loans and relying on funds they have stashed away to cover new investments.
"There's not been a big shift because taxes hit so late in the year with tax-related activity,” he said on the $40 billion-asset bank’s earnings call on Friday. “But overall, customers are looking at the economy as being very strong. They're looking to hire qualified people. And, I would say, we see a little bit of trend of pulling some deposit balances down and investing that in businesses and overall balance sheet strengthening."
Bank of the Ozarks CEO George Gleason said the Little Rock, Ark.-based bank saw a “very competitive environment” in the first quarter. He stopped short of attributing that directly to tax reform, though, and said he expected that to moderate over the rest of the year.
“You typically, in the first quarter, see a lot of exuberance and aggressiveness from your competitors in getting started on their new year's allocation for loans,” he said during the $22 billion-asset bank’s earnings call on Thursday. “It's hard to know how all that competition that we saw in Q1 really translates out over the course of the year. I think that does tend to normalize and rationalize as we go through the year.”
Even PNC’s Demchak said there could be additional explanations for the competition. One of the reasons PNC is running into so much competition for “plain vanilla” C&I loans was simply due to the volume of competition. Most banks offer C&I loans, but fewer banks offer larger and more sophisticated lending products.
“It's not happening on the big syndicated loans,” he said. “It's not happening on asset-based [lending] or anything where there's only really a handful of credible players.”
Indeed, the average commercial loans at PNC rose 6% to $148.2 billion in its first quarter, and company executives said on their call on Friday that they anticipated broad loan growth in the mid-single digits through the rest of the year.
Still, Demchak plans for PNC to tread carefully. Competition for CRE loans has also been especially fierce, and the pricing and structures on some of those loans has exceeded PNC’s own risk tolerance, Demchak said. Its CRE loan growth has moderated in recent quarters, and he said he expects slow growth in that category for awhile.
Demchak said that some of PNC’s commercial loan growth was due to its entrance into new markets, such as Dallas and Kansas City. It takes about a year in a new market to start to break even, and about three years to build up greater loan volume and cross sell more fee-based products, he said.
Without tipping his hand as to where, Demchak also said that PNC could be looking at expanding into more new markets.
“We look for cities that we are not in that have target corporate population that kind of matches off against our product suite and expertise. When we started this exercise, we were less than half, I think, of the large markets that have C&I opportunities,” he said. “Through time, we would hit most of them. I don't know what time means, but we've had success and we will keep rolling out as opportunity presents itself.”
Andy Peters and Kevin Wack contributed to this article