A firm we know needed a $20,000 letter of credit to extend its lease. So, it went in turn to the banks it uses, at each of which it maintains cash deposits well north of an order of magnitude larger than the letter of credit requested. Also, the firm has no debt and has annual revenues in the high seven figures. So, could it get the letter of credit renewed?
Hang on for a tale of excruciating negotiations and thousand-page document requests that left the firm begging its landlord please, please just to take the cash. Note to regulators: no examiners will be harmed in the telling of this true story.
This is not just a tale of two banks over-compensating for all their sins of the past. We think it's also a story with a moral: banks need to right the balance between prudence and service if they are to fulfill their critical credit-intermediation role. And, if they can't or won't, then other providers will happily fill the void. Were this to happen, community banks will see another curtain closed on a core line of business where they have — or, perhaps, had — clear comparative advantage.
The two banks above are a major regional institution and a large community bank. The firm involved has been a customer of each for years — in fact, for over two decades with the community bank. Year-in, year-out, the firm dutifully gives these banks its money to hold and asks nothing in return but the pittance of interest it gets on its various accounts and reasonable operational performance as transactions are handled. In 2007, it did ask the banks for a letter of credit for its lease. At the time, the procedure for getting it was reasonably straightforward. In fact, at the time, one of the banks tried to pitch the firm a few extra services — precisely what one would have thought made sense for any bank that's read up on cross-marketing.
This time around, though, the process could best be described as tortuous. The tale of woe includes demands for corporate tax returns and financial statements for more years than the firm could comprehend, copies of corporate bylaws, demands for validation that the company is a going concern (presumably somewhat evident in the banks' own records of years of relationship) and various and sundry third-party attestations of similarly self-evident stuff.
To top it off, both banks also demanded personal guarantees of the letter of credit despite the fact that one of them also banked several of the firm's principals, who also maintained large accounts that, one might have thought, could easily be checked, found stable, and dubbed more than sufficient.
It was at this point that the company cried foul, tried just to write its landlord a check and generally despaired of banking as it has come to know it. Our tale ends when the large community bank relented and gave the firm the needed letter of credit — at the price of a compensating balance. The company was too exhausted to protest on principle.
Now, back to what was learned from this other than never to sign a lease that requires a letter of credit.
First, it's not to rely on large banks to do anything that a branch manager does upon consultation with a few hundred pages in the rulebook. We respect the rulebook — indeed, we rather wish there had been one a few years ago. But, it's grown misshapen in relation to real risk for customers like the company in this case history. The moral of the tale would have been recourse to community banks except, of course, that it isn't.
Can community banks recapture their luster not just with this customer, but all the others who have run from pillar to post as they too sought credit services in the past year or so?
Not without coming back to a clear-eyed focus on the comparative advantage cited above. It's knowing customers — for real, not just in slogans touting the bank — and, based on that knowledge packaging services no one else can offer because big banks can't customize and non-banks haven't gotten around to trying … yet.
Community banks can and of course should charge for these services. Importantly, risk-management and credit-quality controls can and should be part and parcel of these services. No more "custom" loans to bankrupt construction projects, please, based on the excuse that these are the community bank's goal in life.
If there aren't enough small businesses like the one in our case history to support community banking, then community banking can't be sustained over time. We bet there are, though. Thus, community banks committed to their franchise can in fact prosper — that is, they can if they come out from under the desk.
Karen Shaw Petrou is a managing partner at Federal Financial Analytics Inc.