Easy Money; Can It Continue?
Banks have the money and the willingness to lend, but not many companies want to borrow.
Credit availability to middle-market
companies appears to be cheap and easy.
Borrowing money is never quite that
simple, but we have observed steady downward
pressure on loan pricing for some time.
Now credit terms are loosening, as well. The
question is whether these conditions will continue,
and, if so, for how long.
There is little doubt that banks have both
the appetite and liquidity to lend. As evidenced
by an unprecedented $1.5 trillion in
excess reserves held nationally by banks (see
the nearby chart), liquidity is no constraint
to lending. After bottoming out in late 2010,
commercial credit began to expand again.
Roughly $133 billion in C&I loans have been
added in the past 13 months. But, there continues
to be a far greater appetite to lend than
to borrow, and thus not nearly enough demand
to make a dent in excess reserves.
Ample liquidity coupled with sluggish
credit demand in the midst of a lumbering
economic recovery translates into a highly
competitive lending market. Most of the opportunities
are refinancings, where bankers
are scrimmaging for market share. Demand
for new financing in support of growth, acquisitions
and distributions to owners continues
to be soft, but shows signs of picking up.
Conversations with PNW bankers have a
few common refrains:
Companies that demonstrated resilience
or an ability to adapt in the aftermath of the
financial meltdown have a host of options.
Contrary to the purported quality focus, virtually
any middle-market business with a wellarticulated
business plan can access credit
unless it is hemorrhaging red ink, is already
laboring under insurmountable debt, or is on
the verge of exhausting its liquidity.
Credit spreads continue to tighten due to
the aforementioned competitive dynamic
and long and short interest rates are at historic
lows. Ten-year money can be obtained
at 4% or less. The hunger for assets in this
highly competitive market is leading to a
relaxation of credit standards because pricing
alone may not win the mandate. Collateral
advance rates are easing, covenants are being
streamlined to provide greater cushion, and
personal guarantees are being scaled back. It
is a subtle process driven by competition and
it is well underway.
FROM TOO LITTLE TO TOO MUCH CAPITAL
Three years ago, the federal government
pumped some $105 billion in TARP capital into
the major Pacific Northwest banks (Bank of
America, Wells Fargo, US Bank, JPMorgan,
and Keybank) and another $918 million into
the regional banks (Columbia, Sterling, Washington
Federal, Banner and Umpqua). This
capital has been repaid with the exception of
$417 million that was provided to Banner and
Sterling. Each of these banks raised additional
equity capital in the public (and in a few cases,
private) equity markets and shed capital-intensive
assets in order to repay the TARP funds
and meet regulatory capital benchmarks. As
illustrated in the chart below, all of the PNW
banks now comfortably exceed current riskbased
- "We have a strong appetite for new C&I assets"
- "Quality is an overriding focus, and our credit people are prudent"
- "Leverage levels are stable but we may move a bit higher for the most desirable credits"
- "We can’t believe what our competitors are willing to do!"
CORE CAPITAL STANDARDS
While it seems that capital is abundant
today, there are looming regulatory and market
changes that will create greater challenges
over the next several years:
Credit spreads continue to
tighten due to the aforementioned
competitive dynamic and
long and short interest rates are
at historic lows. Ten-year money
can be obtained at 4% or less.
McKinsey recently estimated that these
factors together will reduce industry returns
on equity from 11% today to 7% by 2015, a development
that is incompatible with the addition
of capital that Basel III will require.
In order to earn appropriate returns on
capital, banks are going to change. Adaptation
to these developments is likely to lead to
a significant industry transformation, driven
by intensified efforts to squeeze the most from
every dollar of capital employed. This focus
on returns is expected to trigger the following:
- Basel Committee on Banking Supervision
sets new and higher bank capital requirements,
known as Basel III, that become effective
- The regulations emanating from the
Dodd–Frank Act establish numerous banking
controls and operating constraints that most
experts believe will step-up the complexity
and costs associated with regulatory compliance
and restrict profitable activities, such as
proprietary trading; and
- Over the next five to ten years, it is
expected that consumers will continue to
deleverage. This trend will erode one of the
banking industry’s most profitable business
Ultimately, businesses require a well-capitalized, healthy banking system, which
should result in greater discipline in pricing
risk and the return of higher credit spreads.
In the meantime, capital and liquidity appear
to be adequate, if not in surplus. It also seems
clear that the gap between middle-market
credit supply and demand is sufficient to drive
banks to continue to battle it out on price
and terms. In the absence of an unforeseen
economic shock, the current credit market
situation is likely to prevail until business
activity really begins to gather the steam necessary
to sop up excess lending capacity, and/
or the banking industry makes some headway
toward addressing its new regulatory and market
Now is an excellent time to reset credit
arrangements on the longest terms possible,
which is best done in a competitive process.
History has demonstrated change often happens
swiftly. There is a wealth of uncertainty
in the world. The sovereign debt crisis, inflation
resulting from the government’s unrestrained
appetite for debt, or the threat of military
conflict is just a short list of the events
that could unravel today’s favorable market
- Renewed fervor for consolidation among
the regional and community banks, in part to
rationalize excess capacity.
- Divestiture of non-core activities, particularly
those with sub par returns.
- Efforts to pare back capital-intensive
branch networks in favor of expanded consumer
access via the Internet and mobile