How to Find Good C&I Loans

It’s no secret that the last couple of years have been very challenging for community banks. Commercial lending in many regional markets has been slow to recover since the Great Recession, and there is such stiff competition for good loans that net interest margins have been compressed throughout the industry. Alliance Partners Senior Advisor Floyd E. Stoner explains how his company’s commercial and industrial (C&I) loan network for community banks can help member banks find good commercial loans outside their markets without taking on excessive credit risk.

Are you surprised that it has taken so long for the business loan market to revive itself?
Yes, I am somewhat surprised that the commercial loan market hasn’t come back more quickly. What happened during the financial crisis had an incredible psychological impact, and businesses are just more wary. Businesses are not as eager to hire full-time employees to grow their businesses, and as a result, there’s been a real lag. I certainly hope that the loan markets will return with vigor, but I think that’s something we’ll know more about a year from now.

Is there a way for community banks to deal with this slow market?
Obviously for any individual bank, they’re trying to find loans in their local communities, as they should. BancAlliance is designed to provide access to commercial and industrial loans that are bigger than the ordinary community bank’s lending capacity. This is the middle market where interest rates are often higher and the loan structures tend to have very robust documentation, typically with audited financials. Gaining exposure to these loans is a strategy that can work for some community banks.

How do you reduce the credit risk inherent in loan participations?
That’s an excellent question, and it goes to the whole design of the model. Alliance Partners is the asset manager that sources loans on behalf of BancAlliance, a cooperative of 190 member banks. Fourteen of those member banks serve on the board of directors of BancAlliance, with one representative from Alliance Partners. Those board member banks approve the credit policies and the underwriting standards, and they engage an independent loan review firm on behalf of the network. Additionally, loans are generally made based on the level of interest expressed by BancAlliance members in a particular loan. Rather than finding random loans and then pushing them down, we look for loans of potential interest to the network. When members do express interest in a particular loan—and no member has to take a loan if they don’t want to—then there’s a much more intense underwriting process. Only if the loan meets stringent underwriting criteria is it made available to members for their final approval. Alliance Partners also sends to members quarterly updates on the loans that they have sourced through the network. The members certainly have to re-underwrite the loans themselves, but they are not responsible for finding the loans.

So you could almost say that each loan participation is underwritten twice—once by Alliance Partners and once by each individual member?
Yes. Alliance Partners fully underwrites and itself owns a piece of every loan made available to members of BancAlliance, and members often reach out to Alliance Partners during their underwriting process to ask questions, request additional information, and also sometimes use fellow members as resources during the underwriting process.

Can community banks still compete in today’s market?
Absolutely. Community banks provide a level of service for their customers and communities that is qualitatively different from that provided by larger institutions. The roles are different. Community banks can handle complexity, but also with more of a personal touch. I think there’s a great opportunity going forward for community banks to become increasingly sophisticated, but also remain relevant to the communities and customers that they serve.

A Holding Company’s Options When Time Is Running Out

Hundreds of bank and thrift holding companies are facing potential default on debt they took on to fuel growth in their bank subsidiaries. Much of this debt was trust preferred securities (TruPS), which had the benefit of counting as regulatory capital for the holding company, as well as allowing companies to defer interest payments for 20 consecutive quarters. For banks and thrifts that may have grown aggressively and later suffered losses, regulators have imposed orders prohibiting the payment of dividends to their holding companies, and without cash flow from their subsidiaries, the holding companies have been unable to make payments on their debt. Now, the end of that five-year deferral period is nearing for many holding companies, and they are facing default. So what should a board do? Kilpatrick Townsend & Stockton LLP’s Joel Rappoport discusses the options for those holding companies.

What strategic options are available for holding companies approaching default?
Most holding companies in this situation will need to raise capital. Relying on earnings alone is unlikely to be enough to persuade regulators to allow a repayment of deferred interest. The best outcome usually will be to find investors to invest in the holding company, or even find a buyer for the holding company, as these strategies will preserve at least some value for stockholders. Anyone who invests directly in the holding company must be willing to take on the debt, because debt must be repaid before equity investors can get any return.

What if you cannot find an investor for the holding company?
If you have a high amount of debt that exceeds the bank’s capital, equity investors may be scared away because they don’t want to take on the debt. In that situation, you could consider selling your bank outright to another bank or investor group that will then recapitalize the bank. You also could try to negotiate a deal with your creditors to take less than what is owed.

What are the obstacles to these options?
It can be difficult to work out a settlement with creditors. First of all, you may have trouble finding someone to negotiate with. Often, the TruPS owner is a CDO, a collateralized debt obligation, which is an asset pool that issues bonds backed by the assets. Some of these pools are managed, and those managers can negotiate a settlement for the CDO. If the owner of your debt happens to be an unmanaged CDO, there is a cumbersome process to get the consent of bond holders to any debt restructuring. There also are tax rules that complicate the process of bringing in new owners or investors. Many banks and holding companies have deferred tax assets that can be very valuable. A major ownership change may mean that future owners do not get the full value of these tax assets. You should try to structure any transaction so as to preserve these tax benefits.

With trust preferred securities, debt covenants don’t allow a sale of bank, so holding companies have to file for bankruptcy because that is the only way a sale can be done. This is called a Section 363 sale, which is the Bankruptcy Code section that allows a debtor to sell assets, and for a bank holding company, the primary asset is the stock of its bank subsidiary. Essentially, it requires an auction so creditors can get the best possible recovery.

What actions will creditors take if and when holding companies default on their debt?
Until recently, creditors fought Section 363 transactions because the results were so poor. Early auctions yielded no competitive bidding and minimal recoveries for creditors. But recent 363 transactions have produced two or more competitive bidders, with much better results for creditors. Creditors now seem to be more comfortable with Section 363 transactions and, in two cases, have even tried to force holding companies to auction their banks by filing petitions for involuntary bankruptcy. When this happens, the holding company might be forced into bankruptcy before it is ready.

What should bank holding companies or buyers interested in them do?
I would say that buyers have an opportunity here to look at these bank holding companies that are under pressure to take action quickly. Holding company boards should explore options early and not wait until close to the end of your deferral period. By then it may be too late, and it may be out of your hands. You may lose the chance to control your destiny.

Case Study: Growth through Niche Lending

Despite a fiercely competitive marketplace and continued fallout from the latest recession, banks that are willing to make the resource commitment can generate loan growth through specialized lending programs. In this video, Steve Kent of River Branch Capital LLC, shares how his client, QCR Holdings Inc., developed a scalable and profitable loan portfolio of niche businesses.

Five Steps to Mitigate the Risk of HELOC Delinquencies

8-11-14-Sutherland.jpgOver the next three years, 60 percent of home-equity lines of credit (HELOCs) are coming due, setting the stage for a new wave of potential credit losses for banks and other lenders. The majority of these loans—opened at the height of the housing bubble when underwriting standards were less stringent than they are today—will reach the 10-year mark between 2015 and 2017. Roughly $30 billion in outstanding home equity loans are due to reset by the end of this year, according to the Office of the Comptroller of the Currency.

As these HELOCs mature, and borrowers must begin to pay interest and principal versus interest alone, many consumers will see their payments as much as triple. A recent report from Moody’s Investors Service illustrates the payment shock in dollars: A homeowner with a $40,000 line of credit balance and a $210,000 mortgage at 4 percent interest could face a 26 percent increase of almost $300 more per month. More shock waves will ripple among borrowers with home equity lines that require a balloon payment; they will owe the balance in full.

Here are five steps banks should take immediately to mitigate the impending HELOC credit risk:

Take a Close Look at the HELOC Portfolio
Banks have a tendency to focus on first mortgages. But now is the time to zero in on the HELOC portfolio and conduct a thorough analysis for potential risks. Look at your borrowers’ credit history. Identify customers who are likely to default. Reach out to these individuals and make sure they know exactly what’s happening and how much they owe.

Be Proactive, not Reactive
Reach out to borrowers whose loans are nearing a reset in payment. Notify borrowers immediately if the bank is going to extend the interest rate. If the payment will jump, tell them when and by how much. Assess the borrower’s current monetary circumstances. Has there been a job layoff or loss of income in recent years? Have household expenses increased due to college tuition or the birth of another child?

Develop Loss Mitigation Programs
Explore flexible, viable alternatives to avoid defaults and reduce losses. Does the borrower have enough equity in his or her home today to refinance out of the HELOC? Develop loan modification programs aimed at HELOC consumers. Be creative and design programs that fit their current financial situations.

Consider Outsourcing
Given the heavy load of impending mitigation issues, it may be tough to handle everything in-house. There are several reasons why banks should consider outsourcing all or part of their mortgage and HELOC operations:

  • Now more than ever, banks need to focus on their core work. Outsourcing HELOC activity will enable them to address home equity issues and allow for a continued focus on core functions.
  • Regulators are encouraging banks and lenders to get ahead of the HELOC issue—a good outsource provider with experience and licenses can handle this swiftly.
  • Regulatory burdens such as the SAFE Mortgage Licensing Act of 2008 and the Dodd-Frank Act of 2010 have squeezed profit margins due to rising compliance costs, making it tougher for banks to be profitable.
  • Rising compliance costs and net interest margin pressure continue to impact banks as they search for ways to streamline processes and cut expenses.

Choose the Right Provider
Many bank executives worry that outsourcing will negatively affect the customer experience. Conversely, the right provider will support and strengthen banking relationships. Here are three key attributes to look for:

  • Domain expertise: Find an outsourcing provider with demonstrated experience in the banking/mortgage industry. You need a provider that understands the complexities of products like HELOCs and mortgages, as well as how cycle times affect the customer experience.
  • Geographical location: Particularly critical for regional banks and lenders, select a BPO with a strong onshore presence to ensure streamlined, timely service to domestic customers.
  • Pricing flexibility: While the traditional Business Process Outsourcing pricing model is calculated based on the cost of employees, consider a provider that can offer transactional or outcome-based pricing, which is most beneficial for banks in terms of cost savings.

For more information on this topic, see Sutherland’s videos on “The Risks and Opportunities of Home Equity Loans” and “Mortgage Outsourcing: Benefits Beyond Cost Savings“.

Two Ways Banks Can Use Interest Rate Swaps

For those community banks competing with larger institutions for borrowers demanding a long-term fixed rate, an interest rate swap may be a viable solution. In this video, Gerrit van de Wetering of BMO Capital Markets shares how two of their bank clients have been successful using an outsourced interest rate swap product.

Mortgage Outsourcing: Benefits Beyond Cost Savings

Rising compliance costs and net interest margin pressure continue to impact community banks as they search for ways to streamline processes and cut expenses. In this video, Mike Baker of Sutherland Global Services outlines how banks can outsource their mortgage lending processing without negatively impacting the customer’s experience.

Growing Your Loan Portfolio

As banks look to fuel their loan growth in this highly challenging market, many are trying to diversify away from a heavy commercial real estate portfolio by looking to other profitable business lines. However, growing the loan portfolio has proven difficult and this session, filmed during Bank Director’s 2014 Growth Conference, shows approaches banks are taking.

Video Length: 45 minutes

About the Speakers

Douglas H. BowersPresident & CEO, Square 1 Bank
Doug Bowers is president and CEO of Square 1 Financial and Square 1 Bank. He has over 30 years of banking experience from Bank of America and its predecessors, where he held a wide range of leadership positions, including head of commercial banking, head of foreign exchange, head of large corporate banking, president of EMEA (Europe, Middle East and Africa) and president of Bank of America’s leasing business.

Wayne Gore, Senior Vice President, BancAlliance
Wayne Gore is a senior vice president of Alliance Partners and has been with the group since its formation. Prior to joining Alliance Partners, Mr. Gore held leadership roles in the financial institutions group with McKinsey & Co. and served as managing director at the corporate executive board. Previously, Mr. Gore was an investment banker with Merrill Lynch and Goldman Sachs as a member of the mergers & acquisitions teams.

Jim Mitchell, President & CEO, Puget Sound Bank
Jim Mitchell is president & CEO for Puget Sound Bank. After spending over 30 years in executive banking roles in the Seattle area, he assembled the team that started Puget Sound Bank. Past local positions include senior vice president and manager of the Seattle corporate banking office of Sterling Savings Bank and senior vice president of U.S. Bank in Seattle.

George Teplica, Senior Vice President and Director of Commercial Banking, The Bryn Mawr Trust Company
George Teplica is the senior vice president and director of commercial banking at The Bryn Mawr Trust Company. He leads Bryn Mawr Trust’s Commercial Banking Group, which delivers credit and other financial services to closely-held businesses, professional firms and not-for-profit organizations in metropolitan Philadelphia.

Should Payday Lenders Prove Customers Can Afford Loans?

4-9-14-Naomi-payday.pngPayday lenders are one of the last financial players in the U.S. market to escape new regulations protecting consumers, but that may not be for long. Banks and other lenders are now operating under new mortgage rules that force them to verify a borrower’s ability to repay the loan. A new set of standards also creates a safeguard against lawsuits for banks and other lenders that stick to a strict debt-to-income ratio and other qualifications for a mortgage loan.

Even banks that offer small dollar, non-residential loans have to worry about federal rules that could come back to bite them. A few banks pulled away recently from offering high interest, small-dollar loans after regulators issued a warning and said they would scrutinize such loans for their affordability and the consumers’ ability to repay.

Payday lenders may soon find themselves falling under regulatory rules designed to protect consumers as well.

At a hearing in Nashville recently hosted by the Consumer Financial Protection Bureau, more than 400 people showed up, many of them employees of payday lending firms hoping to defend the industry against the very real threat of regulation.

They wore yellow stickers, some of which said: “My credit. My choice.”

Freedom to choose, access to credit for all, and innovation in the financial marketplace was the theme for payday lenders that day. It might not carry much weight with regulators since it was the same argument made on behalf of subprime residential loans and creative products such as interest-only and no-doc mortgage loans.

Richard Cordray, the director of the CFPB, said in prepared remarks that the agency is in the final stages of considerations in formulating new rules to bring “needed reforms to this market.” He said the agency intends to make sure consumers who can afford to take out small-dollar loans get the credit they need without jeopardizing or undermining their financial futures.

Payday lenders are not the only source of small dollar, high cost credit (automobile title lenders are another), but they have proliferated in recent years with a fairly successful business model predicated on getting direct access to a borrower’s bank account, taking money before other creditors such as the landlord or the electric company are paid. The CFPB has been collecting thousands of complaints from payday borrowers and released a study it conducted for the past year of payday lending companies’ records showing that 80 percent of payday loans are rolled over, or renewed, by the borrowers in 14 days. Three out of five payday loans are made to borrowers who end up paying more in fees and interest than the amount borrowed, the agency said.

Cordray used the example of a woman named Lisa who lost her job at a hospital and got a payday loan to help pay her rent. She ended up taking out $800 in loans and paying $1,400 back, but still hasn’t paid off all the loans and fees.

Molly Fleming-Pierre, the policy director for Missouri Faith Voices, a non-profit in Jefferson City, Missouri, came to the hearing to talk about a disabled woman with a third grade education she said was targeted for a payday loan outside her workplace. She ended up paying $15,000 to payday lenders before an advocate intervened. A disabled veteran whose wife could no longer work paid $30,000 to payday lenders and yet the couple still lost their home, she said.

An oversupply of bad mortgages made to borrowers who couldn’t afford their loans, which were ultimately packaged into supposedly top notch securities and sold to investors around the world, was blamed in large part for the financial crisis. It’s arguable whether payday lenders could sink the U.S. economy, but the CFPB’s mission isn’t to worry about the U.S. economy, it’s to worry about consumers.

Now, payday lenders may have to start worrying about them, too.

C&I and Commercial Real Estate Lending Still Growing for Community Bankers

12-13-13-Emily.pngJames Tibbetts, vice chairman and former president and CEO of $260-million asset First Colebrook Bank, based in Colebrook, New Hampshire, credits a strengthening New Hampshire economy for the growth he’s seeing at his bank. The bank has locations throughout the state, and the rural economy at the bank’s home in northern New Hampshire depends on tourism and timber harvesting, with Tibbetts seeing increased investment in property and equipment purchases among the small businesses that comprise the core of the bank’s customer base. “Our growth is coming from commercial real estate and C&I lending,” he says. “We do quite a bit of equipment lending.”

With competition for loans and deposits stiff, many community bank executives and boards are looking for the right formula for growth. Many banks are sticking to mortgages, despite rising interest rates and lower volume, instead vying for an increased share of the mortgage market. Still others are focused on the growth they are seeing in commercial real estate and commercial and industrial (C&I) lending.

Industry-wide, C&I loans grew 8.1 percent in the third quarter compared to the same period a year ago, according to the Federal Deposit Insurance Corp. Meanwhile, residential loans secured by real estate fell by .8 percent. Home equity lines of credit fell 8.8 percent.

In November, Bank Director informally polled over 30 bank directors and executives by email to get their views on lending and saw similar trends. In what areas are institutions seeing loan growth? Most of those polled, 73 percent, reported growth in commercial real estate in 2013 and 65 percent reported growth in commercial and industrial lending.

In contrast, the mortgage market remains stagnant, with many reporting a flat market for home mortgage purchase loans in 2013 and almost half seeing a decline in home mortgage refinancing. Looking ahead to 2014, how will the new ability-to-repay rule and creation of “qualified mortgages” impact the mortgage business? Most bankers polled that already offer mortgages indicate that they will continue to be part of their banks’ business in the near future, though some may no longer consider it to be a core part of the business.

Kevin Lemke, a director at Grand Forks, North Dakota-based Alerus Financial Corp., a financial holding company with $1.3 billion in assets, says that while mortgages have slowed a bit, it’s still a strong business for his company, which as of the third quarter of 2013 reported an increase of 4 percent in mortgage originations and loan servicing from the previous year. “I don’t know if we’ll have a record year in originations this year,” says Lemke, “but it will be close.”

Alerus’s broad geographic reach, in Arizona, Minnesota and the bank’s home base in North Dakota help the bank take advantage of strong demand in some areas even as the mortgage business wanes in others. The Minneapolis/St. Paul area of Minnesota is strong for mortgages, and Alerus plans to expand in Arizona.

Lemke feels that his bank is prepared for the qualified mortgage rule, and doesn’t expect an adverse impact on business at his bank. He’s more concerned about rising interest rates. “I think interest rates will have an impact, and already are. I think we will see a decrease in our volume,” he says. “There’s no doubt about it.”

Competition with other banks for loan business continues to be a key concern. To address this, many are hiring new loan staff, offering more attractive loan terms or looking to technology to make the loan process more efficient for clients.

Tibbetts says his bank doesn’t see a lot of competition in northern New Hampshire, but the southern part of the state is a tough market. Pricing is competitive. “It’s all about developing relationships, and that’s how we’re able to grow the amount we have grown,” he says. “We’ve developed those relationships and we price competitively.”

First Colebrook, like many banks, is emerging from a challenging four years. A lot of the bank’s business development and commercial lending staff was stuck tackling problem loans, Tibbetts says, but now the bank can devote more personnel to growing business. “We’re now able to focus on the future and the strengthening economy,” he says.

Growing Your Lending Portfolio with Insurance

Slow loan demand continues to plague many community and regional banks across the country, as they continue to search for ways to grow their loan portfolios. Bob Newmarker of Zurich Insurance offers some insight into how banks can look toward an environmental insurance portfolio program as an alternative way to manage their risks and create a competitive advantage.