The hurrier they go the behinder they get.
This slightly adapted Lewis Carroll adage seems fitting for community banks, which are lending more but are earning less from those loans.
Executives have spent recent weeks griping on conference call about low interest rates and fierce competition for the best loans. The trend is apparent in the first-quarter results at smaller banks.
Loan, on average, rose 7% in the first quarter compared to a year earlier, according to American Banker analysis of roughly 160 banks with $35 billion or less in assets. But net interest income is down 1.6% over the same period. On average, the net interest margin has compressed by 16 basis points from a year earlier.
To some industry observers, the data show that banks are out there fighting for every good loan. For others, it is further evidence that some banks are taking extra risk to build their balance sheets.
Taylor Capital Group (TAYC) in Rosemont, Ill., has started to see "deterioration on the structure" of various loans in the "very competitive" Chicago market, says Mark Hoppe, the company's president and chief executive. "That's the scary part."
Besides pricing, more banks are reportedly loosening standards, such as extending the duration of fixed-rate commercial loans or requiring less documentation from applicants. Higher loan-to-value ratios are also surfacing.
There is a lot of finger pointing. Small banks blame bigger competitors for being too aggressive. Executives at regional banks such as PNC Financial Services (PNC), KeyCorp (KEY) and Huntington Bancshares (HBAN) have frequently stated that they are still acting conservatively.
"We have remained disciplined," Beth Mooney, KeyCorp's chairman and CEO, said during the Cleveland company's quarterly conference call last week. "We are relying on our value-added, relationship-based approach to win new business, expand relationships …and generate robust fee income to go with our strong C&I performance."
Taylor Capital takes a long-term view of pricing, Hoppe says. Total loans at the $5.8 billion-asset rose by roughly 25% from a year earlier, though its net interest margin compressed by 11 basis points. When considering pricing, Taylor Capital determines whether a loan will lead to a broader relationship with the borrower, Hoppe says.
"We have to draw a line in the sand from a pricing and structure prospective," Hoppe says. "You could have significant growth if you threw caution to the wind."
It will be difficult to determine the extent of loosened underwriting standards until the credit cycle turns, says Jeff Davis, managing director of the financial institutions group at Mercer Capital. Lenders stand the best chance of success if they resist the urge to make unsecured loans and avoid deals backed by questionable collateral.
"It's tough to walk away on pricing," Davis says. "If you don't play ball on pricing, you are going to lose the credit. Chances are we are staying in this low-rate environment for several more years, so your portfolio will be repricing lower anyway."
Competition is the most intense for big commercial loans with the most creditworthy borrowers, industry experts say. Smaller banks should consider duration pricing, which involves pricing the expected cash flows of a financial instrument, for such deals, says Thomas Parliment, chairman and CEO of Parliment Consulting Services. This adjustment, already adopted by bigger banks, will help smaller banks compete, he says.
"Smaller banks need to start pricing superior credit quality loans as surrogate investments," Parliment says. "If the choice is to make a loan or buy a bond, the margins are narrowing more with investments."
Rather than enter the increasingly competitive market for commercial and industrial loans, Davis suggests looking into areas that some banks remain wary of, such as home building. There is less competition for these loans and credit standards have remained tight, he says.
Community banks should also focus more on serving small businesses, an area that plays to their strengths, says Dory Wiley, president and CEO of Commerce Street Holdings.
Smaller banks must rethink how they reward employees. Banks should de-emphasize loan growth and instead focus on customer service, says David Rose, chief executive of C-Level Marketing & Sales Consulting.
"Banks are scared to invest in customer service," Rose says. "Customer service has suffered. The problem is that banks are lost in what it means. …The stronger banks are incentivizing employees to focus on more than just loan volume or stealing business."
Banks also need to first focus on building capital and deposits before turning to rapid loan growth, Wiley says. Loan officers who work at banks with strong capital and deposit levels have more flexibility working with clients. "Community banks need to be more than just a place businesses go for a loan," he says.
"They need to be a port in the storm," Wiley adds. "It doesn't need to be all about price but instead about comfort and value added, then you can make a larger spread. That's what community banks are so good at doing."