Cutthroat pricing in the Big Apple is forcing smaller banks to curtail lending to the lower end of the middle market.

New York City bankers say the discounting is being fueled by a shortage of customers and the growing appetites of big banks and other lenders.

They add that the price cutting is pretty much across the board as investment banks and large and midsize commercial banks compete aggressively for loans to companies with $5 million to $50 million in sales by cutting spreads.

"Do I want to match a loan being offered by Merrill Lynch at prime plus one for a company that I don't believe merits more than prime plus 2 plus a 1% fee? " said Fredric Tordella, chairman of the $450 million-asset MTB Bank in Manhattan. "Definitely not."

Reports of price cutting in the sector come despite regulators' repeated warnings against the lowering of credit standards by banks. Bankers add that the current practices are even more surprising since, as recently as three years ago, many large and even midsize banks were still working out good size problem loans left over from the last economic recession.

Till now, bankers say, smaller banks had their pick of credits.

MTB Bank, Mr. Tordella said, has reduced much of its commercial lending as a result of the pricing competition. A spokeswoman for Merrill Lynch declined to comment on the banker's complaints.

"It's a rough market, everyone's looking for loans, and one way to get them is to lower your standards and lower your prices," said James G. Lawrence, president and chief executive at Sterling National Bank and Trust Company of New York, a $707 million asset bank that lends to companies with up to $200 million in annual sales.

"We haven't lost any business but we have become a lot more selective," he added.

At $1 billion-asset Commercial Bank of New York, senior vice president William J. Rossi said he was not surprised at the reports.

"Banks have generally dealt with their loan problems and there's too much liquidity around," he said.

"I expect banks will do the same foolish things they have done historically, that's to say, reduce pricing to get business, reduce credit quality, and by the time next recession comes, have a lot of problems."

Analysts observed that loan price cutting is by no means limited to commercial lending in the New York city region. They added that the lower end of the middle market there has probably been one of the last sectors to feel a trend that has been gathering steam over the last 18 months.

"A lot of the bigger banks are paying more attention to the community banking marketplace," said George Salem, a banking analyst with Gerard Klauer Mattison & Co.

"The smaller guys have been the last to feel it but it's symptomatic of what's going on throughout the bank lending world," he added.

"What we're hearing is that it's across the country and across all product lines," said Pam Martin, director of agency, regulatory, and public relations at Robert Morris Associates, the Philadelphia-based trade association for commercial bank lenders.

"We are hearing continued concerns about predatory pricing and slippage in underwriting standards."

Smaller banks, she added, "don't really have a choice, but even some bigger banks are starting to walk away as well because they feel it won't stand the test of time."

Analysts and bankers also observed that the latest rush by bigger banks and investment banks into the lower end of the middle market is only partly driven by strong capital ratios and high liquidity.

Investment banks, they said, often use lending as a way of getting their foot into the door of a company in the hope that they will be able to underwrite an equity offering.

Meanwhile, slow economic growth in the tri-state area of New York, New Jersey, and Connecticut - combined with declining net interest margins - is pushing money-centers, regionals, and superregionals to look deeper into the market for new customers.

Many are now moving into the lower end of the middle market on the assumption the limited size and large numbers of loans to smaller companies, coupled with computer based credit evaluations and geographically broader operations, makes such lending less risky than in the past.

However, bankers pointed out that similar assumptions drove widespread real estate lending in the late 1980s and early 1990s. The accumulated losses on such loans at banks, although individually small, were enormous, they noted.

Some bankers, apparently stunned by spreads over prime they say are negligible or nonexistent being offered to risky credits, predicted that any downturn in the economy could trigger a large number of commercial-loan defaults in the New York metropolitan region.

"The economy has been fairly strong for several years so most companies look reasonably good," said MTB's Mr. Tordella. "But if a couple of years of results is all you're looking at, you're making a big mistake."

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