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May 2011 “Why Aren't Banks Making Loans?"Business owners and politicians seeking to find a villain in our slow recovery will find banks to be easy targets, but the causes for the nation’s credit crunch have a broad base The question, “Why aren’t banks making any loans?” has been the battle cry of the four-year-old credit crunch that business borrowers and Washington politicians have blamed for our severe recession and, more recently, our slow recovery from it. While it’s an important question that warrants an answer, there are actually many answers, and the blame for the credit crunch can be laid at many doorsteps (not just the banks’). Trying to gain an understanding of the current credit scarcity requires a patient look at all three players in this drama: banks, the federal government, and business borrowers. The Banks Most of the attention has been focused on the banks – the big banks – since they generally have the money that isn’t being loaned. To understand their decisions, let’s step into their shoes. First, a lot of banks are not in great financial condition, and they probably need to get healthier before they pick up the lending pace. By the time the bailout money arrived, many banks were deep in debt, and it will take time to strengthen their balance sheets and build up an adequate cushion. That’s hard to do when they make loans that may not be repaid. (Poor financial health is not a universal condition, however; some big banks are in their strongest capital position ever, thanks in part to help from the U.S. Treasury and to the Fed's interest-lowering activities.) Second, we’re still in tough financial times. Making loans now is a lot riskier than it was when the economy was purring along at a 3-4% annual growth rate. Third, in Arizona we haven’t put the housing crisis behind us, nor have we seen the worst of the fallout from commercial property foreclosures. Indeed, we have yet to see the full impact that the wave of commercial real estate loan defaults will have on Arizona lenders. Fourth, even if a bank were inclined to step up the pace of its business lending, there is a reluctance to be the first lender out of the starting gate. Until one major bank expresses a willingness to be the coal miner’s canary, excessive caution is likely to continue. Finally, there is the profit motive. Banks, like other businesses, need to make a profit – to ensure their survival and to appease regulators and shareholders. But in these peculiar times, the larger banks don’t have to make loans in order to make a profit. In fact, in a rocky economy, with a multitude of shaky would-be borrowers, it can be easier to make a profit by not making loans. Banks can borrow from other banks at interest rates that are set by the Federal Reserve. These interest rates are currently just a shade over 0%. They can use that nearly-free borrowed money to buy 3% tax-exempt bonds and take the spread as their gross profit. Given those conditions, why would a bank loan money to a customer who might not pay it back, when they can make almost 3% on their money and pay no taxes on it? It should be noted that the no-loan profit strategy is more or less the province of the big banks. Further down the food chain are more than 5,000 well-capitalized regional and community banks that are making their profits the old-fashioned way: by collecting more interest on the loans they make than they have to pay on the money they borrow. The Feds Then there’s the federal government, which, in its attempts to support the nation’s banking system and spark economic growth, has issued an array of carrots and sticks that have generally confused the banking industry and delayed the extension of credit. As banks hold onto money to improve their financial position, they face competing pressures from Washington: In one ear they hear Congress and the White House urging them to lend, while in the other ear are the voices of regulators telling them what “type” of loans they can (and cannot) make and exhorting them to build up capital, maximize reserves and rebalance their loan portfolios. Banks also may be nervous about current and future government regulations. For example, last year’s credit card reform act has done little to protect consumers from crushing debt. It has, however, made it more burdensome for credit card companies and banks to manage customer accounts. In response, banks and other lenders are either passing along new costs to account holders or simply rejecting their applications. Finally, in the wake of the 2010 financial reform bill, banks and other lenders are sitting tight, waiting until, first, all of the bill’s provisions are converted into rules and, second, they have a chance to see how the new rules will affect the way they operate – especially in how they underwrite business loans. Borrowers While banks continue to see high demand for business loans, they are not seeing as many qualified borrowers as in the pre-recession period. Many business owners have seen their revenue and net income drop sharply at the same time that banks have raised their lending criteria, requiring higher levels of net income or cash flow and higher credit scores. At the other end of the spectrum are companies that have essentially become self-financing and aren’t interested in borrowing. In many cases, they were so diligent in reducing costs and conserving cash that, as sales started to ramp up, they have squirreled away enough money to capitalize their expansion without the banks’ immediate help. As they cut their expenses, they've gotten more profitable, and they're using that cash first, instead of borrowing. Or they aren’t ready to pull the trigger yet and are simply sitting on their cash until they get a clearer read on where the economy is going. What to Do The rules have changed, and there are more obstacles in your path, but none of these rules and obstacles are necessarily fatal to your business. There are at least two key ways to get your bank to take a serious look at extending credit to your business. First, understand your bank’s lending criteria and try to reshape your personal and business creditworthiness in order to meet the bank’s requirements. If your bank requires all borrowers to have cash flow at least twice the monthly loan payment amount, the burden is on you to find ways to improve your cash flow. If your bank or lender requires your personal credit score to be above a certain level, get to work on your credit score. Reconfiguring yourself and your company to meet bank requirements is a much better strategy than merely applying and reapplying in hopes that the lender will have a change of heart. Second, demonstrate to your bank that you will do all that you can in terms of commitment to your business and to the growth that the bank loan will make possible. You probably don’t want to pledge personal and business assets as collateral, impose a pay cut on yourself and your upper management until things turn around, or borrow from your retirement account, but in the current reality that kind of commitment may be necessary to persuade a lender to take your application seriously. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
