In a long career focused on credit risk, I’ve never found myself saying that the industry’s biggest lending challenge is finding loans to make.
But no one can ignore the lackluster and even declining demand for new loans pervading most of the industry, a phenomenon recently confirmed by the QwickAnalytics® National Performance Report, a quarterly report of performance metrics and trends based on the QwickAnalytics Community Bank Index.
For its second quarter 2021 report, QwickAnalytics computed call report data from commercial banks $10 billion in assets and below. The analysis put the banks’ average 12-month loan growth at negative -0.43 basis points nationally, with many states showing declines of more than 100 basis points. If not reversed soon, this situation will bring more troubling implications to already thin net interest margins and stressed growth strategies.
The question is: How will banks put their pandemic-induced liquidity to work in the typical, most optimal way — which, of course, is making loans?
Before we look for solutions, let’s take an inventory of some unique and numerous challenges to what we typically regard as opportunities for loan growth.
- Due to the massive government largess and 2020s regulatory relief, the coronavirus pandemic has given the industry a complacent sense of comfort regarding credit quality. Most bankers agree with regulators that there is pervasive uncertainty surrounding the pandemic’s ultimate effects on credit. COVID-19’s impact on the economy is not over yet.
- We may be experiencing the greatest economic churn since the advent of the internet itself. The pandemic heavily exacerbated issues including the e-commerce effect, the office space paradigm, struggles of nonprofits (already punished by the tax code’s charitable-giving disincentives), plus the setbacks of every company in the in-person services and the hospitality sectors. As Riverside, California-based The Bank of Hemet CEO Kevin Farrenkopf asks his lenders, “Is it Amazonable?” If so, that’s a market hurdle bankers now must consider.
- The commercial banking industry is approaching the tipping point where most of the U.S. economy’s credit needs are being met by nonbank lenders or other, much-less regulated entities offering attractive alternative financing.
Let go of any reluctance to embrace government-guaranteed lending programs from agencies, including the Small Business Administration or Farmers Home Administration.
So how do banks grow their portfolios in this environment without taking on inordinate risk?
- Let go of any reluctance to embrace government-guaranteed lending programs from agencies, including the Small Business Administration or Farmers Home Administration. While lenders must adhere to their respective protocols, these programs ensure loan growth and fee generation. But perhaps most appealing? When properly documented and serviced, the guaranties offer credit mitigants to loan prospects who, because of COVID-19, are at approval levels below banks’ traditional standards.
- Given the ever-present perils of concentrations, choose a lending niche where your bank has both a firm grasp of the market and the talent and reserves required to manage the risks. Some banks develop these capabilities in disparate industries, ranging from hospitality venues to veterinarian practices. One of the growing challenges for community banks is the impulse to be all things to all prospective borrowers. Know your own bank’s strengths – and weaknesses.
- Actively pursue purchased loan participations through resources such as correspondent bank networks for bankers, state trade groups and trusted peers.
- Look for prospects that previously have been less traditional, such as creditworthy providers of services or products that cannot be obtained online.
- Remember that as society and technology change, new products and services will emerge. Banks must embrace new lending opportunities that accompany these developments, even if they may have been perceived as rooted in alternative lifestyles.
- In robust growth markets, shed the reluctance to provide — selectively and sanely — some construction lending to help right the out-of-balance supply and demand currently affecting one to four family housing. No one suggests repeating the excesses of a decade ago. However, limited supply and avoidance of any speculative lending in this segment have created huge value inflation that is excluding bankers from legitimate lending opportunities at a time when these would be welcomed.
Bankers must remember the lesson from the last banking crisis: Chasing growth-using loans made during a competitive environment of lower credit standards always leads to eventual problems when economic stress increases. This is the “lesson on vintages” truism. A July 2019 study from the Federal Deposit Insurance Corp. on failed banks during the Great Recession revealed that loans made under these circumstances were critical contributors to insolvency. Whatever strategies the industry uses to reverse declining loan demand must be matched by vigilant risk management techniques, utilizing the best technology to highlight early warnings within the new subsets of the loan portfolio, a more effective syncing of portfolio analytics, stress testing and even loan review.
David Ruffin is a principal at IntelliCredit, A Division of QwickRate. He has extensive experience in the financial industry, including a long and pronounced emphasis on credit risk in a variety of roles that range from bank lender and senior credit officer to co-founder of the successful Credit Risk Management, LLC consultancy and professor at several banking schools.
