Big banks want community banks' lunch money, and they're getting it.
With a renewed appetite to expand lending, big banks are said to be actively courting borrowers much smaller than their typical midmarket clients. The banks are wooing potential clients with very competitive rates and loan structures, much to the concern of smaller banks.
"The sleeping giants have awoken," said Dan Yates, the president and chief executive of Brattleboro Savings and Loan, a $186 million-asset thrift in Vermont.
Industry observers said a squeeze from big lenders will press smaller banks at a time where they are under stress from reduced fees, higher regulatory costs and ongoing credit issues.
"Most of the community banks in this country are in a jam," said Jeff Davis, an analyst at Guggenheim Securities. He said commercial clients are slowly showing an interest in borrowing, and big banks are eager to pounce.
"This is a function of the lending thaw wearing off," Davis said. "Larger banks that had pulled back in 2008 and 2009 are attempting to bounce back in a big way in 2011 as markets have gotten better and as liquidity has continued to flow into the system."
"Some of the larger banks are offering unbelievable rates to our largest customers," said Mark Long, the president and CEO of First Commercial Bank in Seguin, Texas. He said the $118 million-asset bank is doing what it can to maintain relationships with its best clients.
In the second quarter, banks with more than $1 billion of assets increased loans by 1.4% compared with a quarter earlier, according to the Federal Deposit Insurance Corp. Smaller banks are losing out. Total loans at banks with less than $1 billion of assets fell 0.4% in the second quarter from a quarter earlier.
Smaller banks are getting hit hard in commercial and industrial lending, which shrank 0.8% quarter over quarter in the second quarter as more than $830 million in net loans rolled off. Big banks are thriving; C&I loans rose 3.3% in the second quarter.
Industry observers said there is no reason to believe that such trends reversed in the third quarter. C&I lending remains an intense battleground for institutions hungry to add good loans.
"C&I has been a highlight of growth, but at a cost," said Fred Cannon, the chief equity strategist at KBW Inc.'s Keefe, Bruyette & Woods, during American Banker's Oct. 31 analyst roundtable. C&I "is only 20% of total loans in the U.S. That's the real issue. If 80% [of the loan book] isn't growing but 20% is, everybody is fighting over that 20%."
"How do you find attractive loans? Well, C&I seems to be one place people look," Brad Whitman, co-head of financial institutions mergers and acquisitions at Barclays Capital, said during the roundtable. "The competition is not just coming from other smaller institutions, but the big banks are in search of that yield as well. So they're dipping into this tier."
Observers said there are historical distinctions between the typical customer and C&I loan for small banks and their larger brethren. Davis said bigger banks usually focus on clients with at least $100 million in annual revenue, but many of those prospects have access to capital markets or other private channels.
So more big banks are zeroing in on the typical community bank client, which typically takes out smaller loans. Davis said a typical bank with $100 million in capital will not make a commercial loan for more than $10 million.
Executives at smaller banks say they are losing business because bigger banks are willing and able to cut interest rates low enough to entice their best clients.
Small banks are unwilling to match the prices due to concerns that they wouldn't price in enough risk. Capital adequacy plays a role; a number of smaller banks are not eager to expose themselves to a new round of problematic loans.
"Pricing at the big banks is getting really skinny," said Peter Brown, the president of Manasquan Savings Bank, an $830 million-asset institution in Wall Township, N.J.
For some, it would be encouraging to see small banks show discipline. Regulators are warning smaller banks to tread softly in C&I, in part because of concerns that loan officers may lack the expertise to properly make such loans.
"You always need to be cautious on the latest and greatest … and everybody seems to want commercial lending now," Darrin Benhart, the deputy comptroller for credit and market risk for the Office of the Comptroller of the Currency, said during the Risk Management Association's annual conference in Washington last month. "That's an area we're keeping an eye on."
Executives at a number of community banks reported instances of bigger banks showing an interest in commercial real estate, an area that most banks have largely avoided since the onset of the financial crisis. (CRE books shrank 0.6% at smaller banks in the second quarter, compared with a quarter earlier. In comparison, CRE loans fell by 0.3% at larger institutions over the same period.)
Michael Bauer, the chief credit officer at Community Bank Shares of Indiana in New Albany, said he knew bigger banks that had offered 15-year fixed-rate CRE loans at less than 4% interest. "All we can do is tell our customers to be careful about what they are signing," he said.
For some executives at smaller banks, including First State Bank in Fairfax, Okla., the strategy for dealing with light loan demand and competition from big banks is simple. If you can't beat them, join them by getting in on participation loans. Marty Hansen, First State's president, said the main reason the $40 million-asset bank is working with bigger competitors is because deposits outnumber loans nearly 2-to-1 at the agricultural lender.
But there is risk with participation loans since the bigger lenders usually hold more sway over how to treat such loans, industry observers said.