Bankers’ Hours column: Banks’ due diligence is making loans harder to get
OK, it’s time to get practical. We’ve done a lot of positing, predicting and presuming in this space for the past several months. We live in a real world, and it’s time to get back to it. Even if most of us don’t understand it and some, like Yours Truly, don’t have a clue.
So what’s happening with banking, and, most importantly, what does it mean for borrowers? In the last financial crisis in 2008, the flash point occurred in September, and within 30 days, major financial institutions and entities were collapsing, including a couple of the biggest money conduits in the world: Fannie Mae and Freddie Mac.
Then, individual banks, from tiny to titanic, by the end of the year were dropping like bad guys in a Bond flick, with the carnage only abating some three years later.
It’s not like that this time, at least not yet. Chances are that banking won’t resemble the post-nuclear economic landscape of 2009. The causes of the two events obviously differ, and are plain to all of us, so we’ll refrain from going into most of them, since we’re talking about banking and need to stay on topic.
That’s not to say that there won’t be some stressful quarters for banks in 2021, and it could be worse for the big guys than the little ones, because the mega-money center institutions lend to all segments of the economy, and the butterfly effect guarantees trauma for all, even businesses not on the front line, such as travel, lodging and dining.
Some big differences between now and then:
In the last financial crisis, much of the assets backing bank loans were egregiously inflated, notably residential mortgage loans and mortgage backed securities made up of those credits. This time some hard assets, including mortgages, are holding value because the underlying collateral, homes, aren’t yet nosediving in value. So far, the always immutable Law of Supply and Demand is maintaining fairly stable real estate markets in general, and some that are actually booming, as exemplified by certain resort venues, including Colorado ski towns.
Another positive factor has been banking’s profitability over the past eight years or so. As the weaker operations collapsed on the trail of the Long March to recovery, many of the survivors got very healthy, and their capital accounts (net worth) blossomed. They have the fiscal resources to respond to ailing assets. In the second quarter of this year the big four U.S. banks set aside $33 billion in loan loss reserves in anticipation of borrower defaults, from corporations to consumers.
In the wake of the Great Recession, lawmakers and regulators focused on measures to prevent future meltdowns, some effective, others not so much. However, one seems to be working as designed: a required annual “stress test” for the nation’s biggest financial institutions. The program, launched in 2013, requires banks above $100 billion in asset size (currently 32 in all) to review capital and reserves to determine if they can survive a hypothetical economic disaster. Since that disaster is upon us, the most recent one conducted in June was meaningful. It was kind of a “This is not a drill” exercise and, encouragingly, all passed, although some just barely.
Finally, the last financial crisis turned the surviving bankers into realists. Unlike half the country, and many politicians, they’re well out of the denial stage of pandemic shock. They know that there are multiple shoes waiting to drop: the number of homeowners in mortgage forbearance programs has been dropping, but there are still 3.9 million of them; the $1.2 trillion in loans to sub-prime corporate borrowers, some now in bankruptcy, continues to loom over the economy; and the sub-prime auto loan business, with mounting delinquencies before the pandemic, isn’t getting any better. These are just a few examples of the footwear to hit the floor.
But banking appears to be doing as much right as can be done to make it to the safe harbor of an immunized planet.
All of this is good news for ultimate economic health, but not necessarily for borrowers on the ground looking for loans. Big banks have tightened underwriting guidelines on every lending bucket in the bank, from credit cards to big corporate loans. And it’s not marginal borrowers that are being shut out. In some instances, a category of credit has been eliminated entirely by some banks, such as home equity loans. Often, top tier corporate borrowers can’t get the kind of financing they’re accustomed to, or the terms they expect.
The 32 operations in the stress test program tend to march to the same drummer in that the heavy hands of the Federal Reserve and the FDIC rest even heavier on their shoulders. Smaller banks are every bit as careful in loan selection, but they have the positioning advantage of being embedded in their respective markets, and thus closer to the action. In short, a so-called community bank generally knows what’s happening on Main Street in a way that a TBTF (Too Big to Fail) institution never can.
So if your bank is one of the really big ones, and the local branch manager tells you no dice on a loan request, it might not hurt to check out our (fictional) hometown depositary, The Second National Bank of Downriver, Montana.
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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