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With recovery, commercial lending finally getting more attention
Date: 7/6/2004
by Don Jacobson
There’s little doubt 2003 was a very good year for banks and thrift institutions. According to the Federal Deposit Insurance Corp., the 9,182 institutions whose deposits it insures earned a record $31.1 billion in the fourth quarter of last year, and $120.6 billion for the year — and that was during a time of fragile economic recovery.
The main drivers behind those sterling earnings were home mortgage lending in the first half of the year, and credit card and home equity lending in the second half. The rush by home buyers to take advantage of record-low mortgage interest rates was an unstoppable force early in 2003, as was consumer demand for all the things that plastic can buy.
It was a different story for commercial lending, though, which remained in a slump that has lasted for three years.
Now, however, there are signs that could finally be changing — as the recovery slowly gains steam, demand for credit from business is picking up as owners move to build inventories, buy equipment and hire new workers. Charge-offs for bad commercial loans fell sharply in the fourth quarter, according to the FDIC.
Meanwhile, with interest rates on the rise and a widely expected rate hike by the Federal Reserve Board in the offing, mortgage lending is cooling off. Mortgage loans declined by 2.6 percent in the fourth quarter of 2003. Given these conditions, the banking emphasis seems to be finally shifting to more commercial lending, according to local observers.
Along with steadier cash flows comes increased creditworthiness for commercial lending customers, said James Denney, managing director at RSM McGladrey’s business consulting office in Duluth.
“I would agree somewhat with the notion that the fundamentals that business bankers use improve as the economy improves,” he said. “Most business lending is driven by cash flow, and bankers’ decisions are influenced by what’s the ability of this business to generate cash flow. As the general business climate improves, you can expect to see businesses expand their investments in inventories and receivables. They need more working capital to do that.”
Denney said banks that specialize in commercial lending will do well, while those that concentrate primarily in home mortgages will probably feel the pinch of rising interest rates. “They tend to stay true to the focuses, so you probably won’t see a business bank turn around and become a mort-gage lender or vice versa,” he said.
Banks that cleaned up on home mortgage lending in recent years face a new reality in 2004, in which home buyers will be fewer and further between. Smart mortgage lenders took that possibility into account during the boom, said Lonnie Swartz, president of Minnesota operations for Superior-based National Bank of Commerce.
“If a bank has a good balance of fixed and variable-rate loans and has protected itself by using some of the hedging tools that are available, (higher interest rates) shouldn’t make a big difference,” he said. “It may be a function of the size of a bank. We’ve got assets of $300 million, so we can be sophisticated enough to perform these functions. But not all the banks are capable of taking on these hedging vehicles.”
While the housing market boom of the past few years proved incredibly lucrative to lenders, it wasn’t a particularly good sign about the overall economy, mainly because it was fueled by a one-time circumstance of historically low interest rates unlikely to be repeated.
On the other hand, expanded commercial lending will be an indicator that a real, sustainable economic recovery is underway, said Tony Barrett, a professor and chairman of the College of St. Scholastica’s department of economics.
“Clearly with the business pickup, the demand for commercial loans is going up,” he said. “Banks will be there ready to provide credit, especially with the higher rates they’ll be able to charge and generate more profit.
“An increase in commercial lending is typical of the early stages of an economic recovery, which is somewhat odd since we’ve officially been in an expansion for nearly three years. In a lot of ways we’re actually in the early stages of an expansion. What it shows is that we’re over the hump and the expansion is finally fueling itself.”
One of the best barometers of the confidence of Main Street businesses is demand for Small Business Administration (SBA) loans. By this measure, 2004 is shaping up as a good year because SBA officials in Minneapolis say they’re busier now than in recent years.
“The number of loans we’re processing is up 30 percent over last year at this time, which in itself was our biggest year since 1997,” said Mel Aanerud, assistant director. “In 2003, we processed 1,748 loans, and so far this year we’re at 1,255, and we’re not even in the third quarter yet, so it’s going to be a significantly bigger year.”
In addition to overall economic improvement an increased business confidence, Aanerud credits a new SBA loan product called Express Loans for increasing loan demand. Express Loans requires much less paperwork for lenders.
He said one of the biggest users of the program in northern Minnesota is American Bank of the North, based in Nashwauk. It’s the region’s largest community bank.
American Bank Chairman Charles Gesme said his $364 million-asset community bank always has focused more on commercial loans to small entrepreneurs than on real estate lending. He has a good view of the recent slump.
“The business community was being conservative and was not looking forward to expanding during the turbulent times,” he said. “We saw a relatively low demand, but we still grew our commercial loans significantly. A lot of that was taking business that decided to go from a big bank to a community bank.”
The SBA Express Loan program was key in attracting that business, he said.
“We’ve been very active in Express Loans because we can take more of the risk of opening a new business. Overall, we’ve had good commercial loan growth already this year. We are seeing people looking at expanding their businesses.”
Gesme cited the case of a resort owner who has decided to put in a new pool, as well as increased confidence from businesses catering to the steel and logging industries.
“The two major industries of our region, which goes from Grand Rapids up to Cook and Orr, are looking substantially better so far this year,” he said.
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