Save "No pain, no gain" for the inspirational speeches; the cynical truth is that someone's pain is usually someone else's gain.
That truth has certainly been on the minds of bankers at the small end of the industry barbell. For years they have struggled to remain relevant as nonbanks, structured-finance vehicles, and large banks pushed them out of their traditional territory — and squeezed profits in the businesses in which they remained.
Now, with credit markets sputtering along after a full-on seizure a couple of months ago, community and regional banks could find themselves in a position to recapture some of the commercial business they had been steadily losing.
Markets-dependent companies have suffered various injuries, some of them lethal, in recent months. Large banking companies that derived substantial business and fee income from selling originated assets are pulling back amid painful loss disclosures.
Perhaps most importantly, commercial real estate loan conduits are drying up for lack of investor interest.
Bankers could be forgiven for feeling more than a shiver of joy from the misfortunes of their competitors, but what comes across instead is closer to a sense of relief — and a validation of the righteousness of their own strategies.
"Over the past three or four years we wondered when all this was going to change. It was almost irrational. Lending standards were loosening too much, and it made it tough for us to compete," said Bernard Clineburg, the chairman and chief executive at the $1.8 billion-asset Cardinal Financial Corp. of McLean, Va. "What we're seeing now is the tip of the spear, and if it continues, commercial banking will come back into its own. And it has been a commodity for the past 10 years."
Commodity, of course, is a dirty word to a community banker. Over the past 20 years efficient, liquid markets evolved for historical banking staples such as mortgages, car loans, and credit cards. The qualitative difference that community banks had long marketed — service and relationship — lost relevance, and their share of these lending markets has dwindled to become immaterial.
Community and small regional banks have crowded into commercial real estate for growth to such an extent that it is hard to find one that does not have a substantial portion of its loan book in commercial real estate or construction and development.
These banking companies occasionally have significant commercial and industrial portfolios, but bankers readily admit that these credits are frequently an extension of the prime asset that many small businesses have: land, buildings, and physical plants. Booking the C&I loans — lines of credit, term loans, trade finance, equipment loans, receivables financing — depends on keeping the commercial mortgage.
That's why community bankers have seen the growth of conduit financing in recent years as a particularly virulent threat, and why they are breathing easier now that conduits appear to be retreating.
By using the resources of insurance companies, pension funds, hedge funds, and other large entities through the conduits, borrowers consistently secured cheap funding. Small banks scrambling to remain competitive gave up margin to do so.
This summer's freeze in credit markets has had a lasting effect on the conduits. Though the large institutional lenders still have dollars to lend, they have lost faith in the fee-heavy, opaque structures that Wall Street sponsors used to connect borrower and lender.
Bankers are primed to pick up the slack.
"The third-party conduits have really stepped back, and the community banks are able to make loans," said Matthew Schultheis, an analyst at Ferris, Baker Watts Inc. "Suddenly a commercial real estate loan they wouldn't have bothered to price six to nine months ago, now they are back in that market."
All bankers have heard at least rumors about the demise, if only a temporary one, of conduit financing, but not all are reporting material changes in their markets yet.
"We are hoping that what is happening to conduits will reduce the level of fierce competition that we have experienced in that market," said Carol Nelson, the president and CEO of the $1.3 billion-asset Cascade Financial Corp. of Everett, Wash. "We are hearing anecdotally that locally, the conduit market is starting to dry up, and we would really like to see that."
But Steven Rosso, the CEO at the $404 million-asset Pacific State Bancorp of Stockton, Calif., said he is seeing more definitive signs of retreat in his market, following a period of aggressive pricing by conduits that increasingly extended their reach down market.
"Due to the liquidity issues, there is less money out there to offer. Some of the conduit financing was getting down to loans under $2.5 million," he said.
Conduit sponsors, including insurance companies, "have pulled back," Mr. Rosso said. "It opens the door for us to do business in a smart and rational way within our marketplace."
The dislocations in the credit market will not keep the conduits out of the commercial real estate markets forever, but some bankers say there will be a structural shift back to more reasonable pricing. Excess liquidity in capital markets — apparent everywhere until this summer — had crushed credit spreads. Because banks' natural borrowers are companies that do not carry investment-grade ratings, they felt the inability to price risk acutely.
"For the past couple of years, risk was basically priced the same," said George Jones Jr., the president and CEO of the $3.9 billion-asset Texas Capital Bank in Dallas. "We see the risk premium beginning — beginning — to creep back into the market. That transaction that borrowers could do at Libor plus 150 is maybe going to be plus 200 or 250."
And bankers are hopeful that some of the downsides of conduit financing are becoming more apparent to commercial real estate borrowers. The structures depend on steady cash flows to such an extent that prepayment is typically forbidden, forcing borrowers looking to refinance to complete expensive defeasance transactions. The conduits frequently require cash management and reserve accounts that put large portions of cash beyond the borrower's control.
When dollars were washing through the financial system, those conditions did not seem as punitive as they do now. Bankers say that tough times can make borrowers fixate less on pricing and more on service.
"In times such as we are facing today, sometimes rate isn't everything," Mr. Rosso said. "The customer knowing the bank and the bank knowing the customer may be worth more than saving 100 or 150 basis points."
Kevin Reynolds, a regional president at Cardinal, said pricing has become a "secondary question" replaced by soft factors that should favor banks that emphasize relationships. The market "is moving away from a commodity with pricing as the determinant, to 'Tell me who your CEO is, who are you top bankers, and can they deliver on their promises?' "
There is no guarantee that the market will continue to move back toward relationships over rate. Conduits with more transparent structures and clearer advantages for lenders could still offer rates that the small banks could not touch. And there are legitimate questions about the value of the business that bankers are winning now.
Regulators are worried enough about commercial real estate and construction and development lending that they are scrutinizing banks with heavy portfolio concentrations in those areas closely. The guidelines, however, exempt the owner-occupied loans on which the small banks have feasted.
And, of course, there is growing concern about just how confined credit woes are. With housing markets in full-on retreat, the problems could spread easily.
"My concern is about the support industries — the guy that does the drywall, the plumber, the electrician. Those groups are not going to see the work that they have had in the past from home building," said Randy Ferrell, the president and CEO at the $486 million-asset Fauquier Bankshares Inc. in Warrenton, Va. "That affects mortgage payments, car payments, and a lot of things. We haven't seen the effects of that on our delinquencies as of yet, but the longer it goes — until that housing inventory is sold and we start building again — we are going to see pressure. It affects not just the businesses, but their employees, and that bleeds to the consumer side."
So even though the once-disadvantaged bankers are plying their newfound leverage, most are doing so carefully.
"It's a time for all banks to continue to actively monitor their portfolio. It is not a time for unbridled growth," said Mr. Jones of Texas Capital. "There is definitely opportunity, but you can't ignore what is going on nationally. Cautious growth in this environment is the right way to look at it."
