The changing face of banking

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Banks are still lending money. But they’re doing so carefully and cautiously, 
and with greater regulation than ever before.

Story by Sean Fitzgerald, New North B2B Publisher

Given the tumultuous headlines three years ago using terms like Bear Stearns, Too Big to Fail, Lehman Bros. and Troubled Asset Relief Program – or TARP, for short – one might have thought the U.S. financial industry was in collapse.

Since that time, if you attend any conference of business owners and managers in a given industry, there’s invariably at least one break out session covering a certain topic about financing. And in that session, there’s at least one question – if not an entire agenda of discussion – focusing on the perception of why banks are no longer lending money.

It’s certainly not a universal perception among business owners, but it’s a question heard more often at business networking events.

The question bears some consideration, because on its surface, the financial industry appeared to change overnight to most laypersons not actively involved in lending on a day-to-day basis. That being said, any perceptions of a financial fallout during the past three years didn’t come primarily as a result of problems with commercial loans, but overwhelmingly more because of the sub-prime mortgage crisis. That market dynamic did lead to even more regulatory authority and increased scrutiny on the banking industry.

Still, a number of lenders – particularly those who toughed it out during the past three years and didn’t have to pick up the pieces of a shattered loan portfolio – do have money to lend and have been actively looking to make loans. The difference is that the risk that banks are willing to take – or even allowed to take – on loan deals with little money down, speculative projects with little-to-no proof that it will cash flow positively, and lack of sound management practices from the borrower are now part of a bygone era in business finance. Financial institutions which previously did lend with such flighty judgment were more susceptible to problem loans. Those who stuck to sound banking principles often did all they could to stave off troubling loans without cutting off lending altogether.

Real estate woes

The real estate and new construction market was hot from the late 1990s into 2007 and 2008. Many felt that if they didn’t get in on the action of making more development happen, they’d miss earning their share of profit.

Unfortunately, in all the excitement a hot commodity has to offer, loans were made that probably shouldn’t have been approved in the first place.

The excess capacity of available real estate in the market since 2009 – particularly retail and office space – combined with the plummeting value of those properties created a recipe for potential disaster. A number of the owners of these properties – often multi-tenant, multi-use developments – had difficulty generating sufficient revenue to make the payments on their loan to the bank. When those developers defaulted on the loan and the bank took possession of the property, the financial institution often couldn’t sell the real estate for what it was worth. That left some financial institution’s  loan portfolios in rough shape.

“We probably, like a lot of other banks in the area, got overly involved in the real estate sector, specifically with development loans,” said Steve Tramp, the Fox Valley market president for Associated Bank. During the past three years, Associated has been able to significantly reduce the number of problem loans it previously had in its portfolio, Tramp said, a trend indicated in the publically-traded company’s financial reports during the past four quarters. Associated is back to profitability after a challenging 2009, and this past September it paid back the remainder of the $525 million in federal TARP funds it was issued nearly three years ago. The bank still does loan for certain real estate development projects, Tramp said, but he said bank officials scrutinize those deals much greater than before.

A number of the financial institutions we spoke with in northeast Wisconsin either didn’t have an excessive amount of nonperforming commercial real estate loans heading in 2008 or were able to shed a number of their loan quality problems just as the bubble was set to burst, leaving them in comparatively better shape. All of the bankers we spoke with said there’s likely not going to be a return to lending on real estate developments based on speculation alone. If the project isn’t producing a positive cash flow from the day the doors open, and if the loan-to-value ratio is too high, such a loan simply won’t be made from a financial institution.

Slow economy isn’t helping

The chicken-or-egg question of whether lending spurs the economy or if a revved up economy spurs loan requests if difficult to answer precisely. If anything, action by the Federal Reserve Board during the past three years would seem to indicate that just because lending rates are lowered doesn’t mean consumer demand is going to climb in proportion.

If anything, when the economy slows, the demand for new capital slows along with it, said Tim McFarlane, president and CEO of Fond du Lac-based Hometown Bank.

Hometown has grown its book of business during the past few years primarily through its strength using various loan guarantee programs through the U.S. Small Business Administration. The SBA had eliminated most of its fees for new loans – enticing businesses to seek additional financing – and the federal agency also increased the amount of guarantee it would back on those loans, removing some of the risk for banks to make loans on deals where they might otherwise ask for substantially more collateral from the borrower, or perhaps wouldn’t have even made the loan at all.

“As a result of (the SBA loan enhancements), we were able to very cost effectively raise new business,” McFarlane said. Hometown has ranked among the top SBA lenders in the Wisconsin so far in 2011, an accomplishment McFarlane said is a testament to his lenders’ knowledge and understanding of how to work with SBA programs.

Universally, though, demand for new capital is simply down. There’s far less inquiries for financing coming in from start ups, said Peter Prickett, president and CEO of First National Bank-Fox Valley, a Menasha-based financial institution with locations in Winnebago and Outagamie counties.

“We want to lend,” Prickett said. “Good deals will get done. It just might take a bit longer.”

Still, FNB isn’t experiencing enough qualified demand from businesses needing to extend their lines of credit or take out new capital to grow. As a result, Prickett said his bank is sitting on historic record levels of deposits, a scenario many financial institutions are facing.

Nicolet National Bank has been growing its loan portfolio year over year since 2008, and looks as if it will do so again for fiscal 2011, said Mike Daniels, president of the Green Bay-based bank with 10 locations from Outagamie County north to the Marinette and Menominee area. The bank was a recipient of $15 million in federal TARP funding, which it also repaid in full this past September.

Nicolet used the additional funds to continue lending during the downturn in the economy. As a result, the bank sacrificed its earnings for 2008, pushing that income back further into 2009 and 2010.

“We took a position that cost us a lot of money,” Daniels said, acknowledging that the strategy helped strengthen relationships with customers by meeting their needs during a critical period.

Relationships crucial

Building a strong relationship with clients is perhaps more critical now than during times when the economy is healthier.

Business owners, like consumers, can be fickle and chase down new capital as if it’s a commodity, going to five different financial institutions in order to get the best deal – or even trying to find one that will give a loan when no other bank will approve any financing.

“It’s not Burger King – it’s not like you can have it your own way,” said Nicolet’s Daniels, who said the relationship between a banker and their client is an intangible amenity that can make the difference in terms of knowing what a business truly needs to survive and grow compared to simply giving the business owner what it thinks it wants. The two aren’t mutually exclusive.

“You can’t get top-notch relationship banking when you’re looking for a commodity,” Daniels warned.

Such relationships can also be critical to a business owner concerned about the uncertainty of the economy, noted Tim Lamers, vice president of Appleton-based Business Lending Group. As the old adage goes, ‘the devil you know is better than the devil you don’t know.’

“If people are with a financial and they’re happy, they don’t want to change because they don’t know what’s going to happen,” Lamers said.

Maintaining a tight focus on a client and a particular industry – instead of trying to be all financial solutions to all businesses – is what helped First Business Bank successfully endure the recession without creating any issues for its commercial loan portfolio.

The bank has successfully carved out a niche for itself serving certain industries, said the bank’s Northeast Wisconsin President Mickey Noone, such as manufacturing, wholesale/distribution and transportation, as well as a limited amount of medical and commercial real estate developments in its portfolio.

“If a loan request comes to us in the industries we’re not in, forget about it,” said Noone. “I think what you’re going to see within the next few years is banks specializing in the markets that they serve.”

While a ‘boutique’ approach to banking isn’t entirely new to the industry, it’s an approach that will allow smaller financial institutions to set themselves apart from their larger competitors.

When the economy turns

After a nearly two-year run, the federal government discontinued its fee waivers and higher loan guarantee rates on SBA lending programs at the end of 2010. In a post-TARP era, Congress approved a Small Business Lending Fund earlier this year aimed at opening up additional capital to banks with assets of less than $10 billion.

Nicolet, Horicon Bank and FNB-Fox Valley are among the handful of lenders in the state participating in the program, which Daniels said is helping it make loans to businesses in situations where other banks might not have the liquidity to do so.

Unfortunately, without much growth in the economy, new clients for one bank typically means the loss of a client from another. Growth for the entire industry will only come when demand for commercial loans from qualified borrows picks up, and that’s unlikely until the economy shows sustainable progress.

“We’re starting to see a small pick up of demand, but it’s nowhere near where it had been 10 years ago, or 5 years ago,” said Tramp from Associated Bank. “Unfortunately, right now, it’s a matter of everyone trying to get a bigger piece of the pie. We would eventually like to see the pie get bigger.”