The Latest from Banker Guy
From my anonymous bank CEO, whom you can reach via firstname.lastname@example.org:
FACT: Banks are making loans.
Maybe not all banks but many banks are making good loans. My bank and many of my competitors are making loans. Having said that, we are not getting a lot of loan requests and loans that we do make are on conservative terms to existing relationships or a few key prospects where we will get a relationship. Relationship means that we have all or most all of the customer’s balances and the customer’s other banking business.
When a bank makes a loan it uses capital. For every dollar loaned, a bank generally reduces capital by ten cents. In a recession where loan losses are probable and capital is very scarce it must be rationed carefully. Conversely, if a banks needs to increase capital it can do so by reducing loans. So if a regulator or the market says you need to raise capital, then you will not make loans and will reduce them.
This raises the topic of TARP capital. The treasury purchased perpetual preferred shares from banks. That investment pays the Treasury a dividend of 5% currently; in addition the Treasury received an option to purchase shares equal to 15% of the amount invested. Banking 101 says that you safely invest capital in order to support deposit taking and lending activities. As noted above, one dollar of capital will support about $10 dollars of deposits and loans. Politicians asking if a bank has loaned its TARP capital do not understand banking. Banks are intermediaries; they take small deposits, aggregate them, and loan them to creditworthy borrowers. They make money by charging more for the loan than their cost of deposits, expenses, and loan losses. (I know this is elementary but it seems so few understand the basics.) If the government wants to increase lending, they should make low-cost deposits with banks which they could then lend.
Let me return to the fact that banks are making loans. My bank and many other banks in my area are making loans on these terms: The borrower must have collateral, like real estate or liquid assets. Loan-to-values would range from 70% to much less depending on the quality of the collateral. Borrowers need to have strong cash flow that well services the loan. We generally will charge Prime plus with a floor of 5.5% or more depending on deposits and the overall relationship. Favored borrowers are commercial and industrial businesses, especially with owner-occupied real estate, income-producing properties, professionals, and individuals. No loans are being made for real estate development or speculative home building. Every loan is with recourse to the individual owner or investor.
We are making some mortgages on single family residences that are above Fannie and Freddie limits. The loan-to-value is at least 80% and the debt-to-income ratio is below 35%. We only make one, three, or five year adjustable rate loans with a 30 year amortization. We charge at least 6.5% for a three or five year loan.
This is the kind of lending that makes sense. It is based on sound credit principals, provides adequate return on capital, and supports good business and the growth of the economy. We are not competing with unregulated non-bank lenders who had much lower capital requirements and lower cost of funds or ignoring credit by snowing rating agencies with complex models resulting in bogus AAA ratings.