Pooling Resources to Buy Middle Market C&I Loans


Community banks have been pushed, squeezed and shoved out of the lending market during the past two decades for many types of commercial and industrial loans, where the pricing has become so competitive that it’s not worth the effort. But with the pitfalls of high concentrations in commercial real estate so obvious now, many banks are trying to diversify revenue streams in order to survive. John Delaney and Lewis “Lee” Sachs founded asset manager Alliance Partners in June 2011 to help community and regional banks diversify income and gain access to C&I loans too big to otherwise put on their books. The related entity, BancAlliance, is a cooperative of member banks that identifies, evaluates and refers loans to members. Bank Director magazine talked to John Delaney and Lee Sachs about the market for C&I loans and how their company works.

Why did you think there was a need for this?

Lee Sachs: From the bank’s perspective, for the last 20 years, they’ve been pushed out of so many different markets. As a consequence, community banks have gone from having around 60 percent of their loan assets in real estate to some having almost 80 percent of their assets in real estate. That is not a sustainable business model over time.

John Delaney: Banks do better when they have balance and choice, and the problem with community banks is they don’t have balance and they don’t have a lot of choice. A lot of community banks have just become local real estate lenders. Much of the growth occurring in our country is in the middle markets. The U.S. is more of a service economy and service-based businesses tend to be more regional and national, and you need a certain amount of scale to successfully compete for loans in that market. Right now, a disproportional benefit of that growth goes to large banks. If you look at where jobs are being created, it’s at fast growing, mid-sized business that go from 100 employees to 1,000 employees in a couple years. The middle market requires loans of $50 million to $250 million, which are bigger than what a lot of community banks can handle. However, these borrowers would prefer to do business with community banks. Truly, that’s what they would rather do.

Lee Sachs: Sometimes a Main Street bank will lose a client as that client grows, because the bank can’t accommodate the larger loans. One of the things we help our members do is retain that client.

Who are your members and what does it cost to join?

Lee Sachs: We have 38 members and they’re all over the country, from $200-million asset banks to $10 billion. They don’t pay anything to join. We receive asset management fees based on the volume for the loans they fund through BancAlliance. The banks set the parameters for the loans, policies and procedures, and they tell us what kind of loans they want. Each individual loan may or may not fit with every bank’s needs. We introduce a loan to the membership and each member decides if that loan works for them. We service the loans on behalf of the group. We consider ourselves an extension of their loan department.

John Delaney: We’ve looked at 450 opportunities, and a little less than 10 percent made it through our filter, so 40 loans have been approved on behalf of the network.

C&I lending is a fairly competitive business, especially in terms of pricing, so how do you think you can offer a strategy that will be attractive to community banks?

John Delaney: For small banks, there are too few opportunities in C&I lending and too many banks going after that. In terms of national credits and mid-sized businesses, we find that to be a market that has average competition. We don’t think it is nearly as competitive as the C&I loans in the local footprints. The return profile is better and the risk profile is better.

How do the regulators view your model?

Lee Sachs: We’ve gotten good feedback. We are doing this very carefully; we designed this in a way that fits with regulatory guidelines. The former Comptroller of the Currency, John Dugan, has been outside counsel for BancAlliance and has been instrumental in helping us think this through.

 

Thriving by Giving Back


tom-parker.jpgWith all the stories about banks below $1 billion in assets struggling to compete, a story about a small community bank returning to profitability with a community-oriented strategy deserves some attention.  The Bank of Santa Barbara in California may only have around $100 million in total assets, but ever since a group of philanthropists took controlling interest of the bank in 2009, it has been working its way towards strong capital, high liquidity and steady growth—all while supporting community organizations.   

The Hutton Parker Foundation, which supports community-oriented nonprofits, was one of the key investors in the 2009 buyout of The Bank of Santa Barbara.  Thomas Parker, president of the Hutton Parker Foundation, recently spoke with Bank Director about the symbiotic relationship between his foundation and the bank. 

Could you tell us about how the Hutton Parker Foundation and The Bank of Santa Barbara are working together, and how you came up with the idea?

Private foundations generally invest their money in Wall Street, and they are mandated to take 5 percent a year and donate it back to charity. 

Once I started [working with the foundation] in 1996, I looked around and I said, “You know it’s great to give away the 5 percent, but is there something we can do with the invested capital?” In other words, instead of investing it in Wall Street, why don’t we invest in our own communities?  So, I started making loans to nonprofits.  I bought buildings and created nonprofit centers.  Then, I went a step further and said, “Here’s an opportunity for the foundation to not only make a nice return, but also invest right in the community by buying stock in a local community bank.”  I got a number of other foundations, along with other individuals, to do it with me. It seemed like a great way to invest.

Not only can I invest in a [community bank] with our capital and make a nice return, but there are synergies that take place as an investor.  We have great insight into nonprofits.  Nonprofit employees equal 10 percent of the workforce, so a lot of loans go out to nonprofits.  Banks are kind of reticent [to make loans to nonprofits] because they don’t understand [them].   We have the ability to guarantee loans on certain projects if we know they are secure, and not only that, we know they benefit the community. 

How is the foundation involved in determining which nonprofits receive loans?

It’s really the nonprofits themselves that come to banks.   We don’t have much influence.  The [bank officers] certainly ask me how I feel about this kind of a loan when nonprofits are involved, but as far as the day-to-day operations—no.   I don’t influence the bank on whether they approve or disapprove a loan.  I’m only there as a resource if the [officers] happen to have questions about the nonprofit’s capacity.  This is a passive investment as far as management is concerned, but it’s an active investment as far as trying to work with the bank to make the community a better place.

So you have partial ownership of the bank?

The maximum amount of stock we can own in a bank is 20 percent.  And once we go above 10 percent, generally, any foundation or corporation pretty much has to sign a passivity agreement, which works fine for us.

How many different foundations is The Bank of Santa Barbara working with?

I think right now there are probably three.  There are two foundations and another major philanthropist owning approximately 50 percent of the bank stock. 

What is the average loan The Bank of Santa Barbara makes to a nonprofit?

It varies from a $10,000 to $20,000 line of credit to a $3 million to $4 million secured loan for a building. 

What happens in the event of a default on the loan?

If the foundation guarantees the loan to a nonprofit, the foundation would be on the hook in the event of a default.  With most of the loans like that, they are buying a building or rebuilding a theater, and they have pledges from people we are familiar with that we know will be honored.  They just need the ability to borrow in the interim until those pledges come in over two or three years.

Any advice you would give to community banks considering starting a relationship with a foundation?

Absolutely.  Knock on the door and start the conversation.  You never know the reception you will get, but it is certainly working in our case.  It’s about running the bank for the community, and knowing that a properly run bank can make a nice profit and that profit can then be given back to the community.  And I know that that resonates with depositors and with people that live within that community.

There are currently a lot of private foundations out there with more than $1 trillion in assets. That $1 trillion private foundations hold is primarily invested in Wall Street. There’s a trend right now for all of us in the private foundation field to look around and ask: “Is there a better way to invest our assets and still get a good return?”

A Butterfly Flaps Its Wings In Europe


The Opportunities for Community Banks Arising From the European Debt Crisis

butterfly.jpg

Most of the commentary on the financial crisis in Europe has focused on the acute challenges policymakers must address today, an approach that makes sense given the consequences for the global economy if those issues are not addressed adequately.  Less attention has been focused on the opportunity the crisis has created for our own community banks.

The combination of the financial crisis that struck our own country three years ago and the fallout from the European debt crisis may be creating an opportunity for community and regional banks to retake market share lost over the past 20 years.  During that period, community and regional banks lost significant market share in almost every loan class, with the glaring exception of real estate lending.  The resulting real estate dependent business model has now been called into question by both investors and regulators, and it is hard to see growth opportunities or even long-term survival for community banks that do not adapt to the new environment, in which balance sheets saturated with real estate loans are regarded with growing skepticism.

In a silver lining to the European debt crisis, the retreat by many of the world’s largest banks is providing new lending opportunities for those community banks that have steadily grown their capital and liquidity over the past few years, and are contemplating new ways of generating prudent loan growth.

Until recently, European banks have provided credit to American borrowers across a wide range of sectors, including small and medium business enterprises.  Historically, these markets were fertile ground for community banks, but in recent years those banks have seen themselves become less relevant in many of those sectors.  While the ultimate outcome of the European situation is unclear, we can be confident that European banks are going to continue to be severely constrained, with substantially less capital reaching our own lending markets.     

To give some context for the magnitude of this withdrawal, the European Banking Authority last year announced that European banks must reach a 9 percent Tier 1 capital ratio by June 2012. In aggregate, European banks would have to raise over 100 billion euros of new capital to reach this target with their existing balance sheets.  Rather than raise this much equity, however, many European banks have indicated that they intend to reduce their balance sheets to meet the capital target.   Estimates suggest that balance sheet reductions could exceed 1 trillion euros. While we do not yet know how much of that reduction will take place in the U.S., some European banks are already pulling back from our market.

There is no reason for this void to be filled exclusively by the country’s largest banks.  Many, if not most, of these U.S.-based assets and loans are appropriate for banks both large and small.  The challenge for community banks in accessing these loans is two-fold: a question of access and a question of understanding the credits.  As these banks engage in markets they may have exited years ago, they need to ensure that they understand the loans they put on their books, and remember lessons learned from the recent real estate crisis.  In some cases, the move back to traditional commercial (non-real estate) lending may require investing in the education of loan underwriters and credit officers who find their skills outside of real estate lending may have become rusty. 

In order to have access to the best credits surfacing because of this disruption, and to defray the associated sourcing, underwriting and servicing costs, we believe that community banks that choose to work together will be best positioned to compete with their larger brethren.   They will be able to fill lending gaps left by the European banks and take advantage of the tail winds finally blowing in their direction.

Lending in an Uncertain Economic Environment



Joe Evans, chairman and CEO of State Bank Financial Corp out of Atlanta, shares his lending strategy in a weak economy and tumultuous real estate market in Georgia.

Over his 30 year career, Joe Evans has run some of Georgia’s beset community banks. In December 2006, Joe Evans sold Atlanta-based Flag Financial Corp. to the U.S. arm of Royal Bank of Canada for $456 million. Since starting State Bank, Evans and his team have acquired several failed banks in the Metro Atlanta area.

In 2011, State Bank was named the top performing bank in the United States by Bank Director magazine in our 2011 Bank Performance Scorecard, a ranking of the 120 largest U.S. publicly traded banks and thrifts.

Watch the below video filmed during Bank Director and NASDAQOMX’s inaugural Boardroom Forum on Lending held last December in New York City.

Back to the Future: The Road Forward


road-ahead.jpgWith traditional bank lending, one of the credit risk red flags was always a lack of borrower diversity. How could a company risk having all its eggs in one basket? The extra pain extracted from highly correlated bank portfolios (i.e. both with real estate and geographic concentrations) in this crisis has brought that proverbial chicken home to roost in our own industry. Conceptually, we all now understand this; how do we practically affect this change?

Here’s a possible five-step plan for your bank to consider:

Step One: Adopt strategic plans that include alternative loan products, such as those tied to C&I (commercial & industrial) lending, or indirect / dealer automobile lending or even mortgage warehousing. Small Business Administration loans are another possibility. Recruit the talent that can implement these strategies for you.

Step Two: Disabuse yourselves of the following anti-C&I biases:

  • It’s become just a consumerized product. This is a byproduct of the underwriting laziness adopted by many, where a small business owner’s credit score was the primary driver for this loan product.
  • It’s tantamount to unsecured lending. Because it tends to focus on the top of the balance sheet, assets for collateral, lines of credit can be monitored effectively by procedures that use collateral such as stepped borrowing base agreements.
  • It’s asset-based lending. We’re not talking about factoring-like products (buying or funding a customer’s accounts receivable at a discount) that proliferated the ’90’s. They often failed because they were unwisely sold to banks as having primarily operational rather than credit risks at their heart.

Step Three: Ditch (or at least modify) the hunter-skinner delivery system for your bank’s loan officers. It doesn’t work. Some of the so-called efficiencies gained lend themselves better to the book and forget mindset that too often characterized our industry’s fixation on commercial real estate. This strategy also robs us of broad-based credit talent needed to fulfill the axiom: the market place rewards value-added.

Step Four: Train and re-train lenders and related lending staff (analysts, underwriters, credit officers) in the ways of cash flow and cash cycle analyses. Twenty years ago, most commercial bankers were experts in these classical credit tenets—and frankly treated real estate as a form of specialty lending. Over the past decade, commercial banks have been copying mortgage lending, abdicating too much of their core underwriting to third parties such as appraisers and credit rating agencies. The fundamentals of classic credit underwriting are not that intimidating—and like riding a bike, can come back to even the most dedicated commercial real estate devotees.

Step Five: Create the infrastructure needed to deliver and oversee this diversity investment. In addition to front-end underwriting, enhance:

  • Use of practical loan covenants and borrowing base certificates to justify lines of credit;
  • Portfolio servicing (post-booking checks of a borrower’s risk trends);
  • Probative risk management tools (looking at future risks);
  • Staff. Remember, the cost of one or two additional full-time equivalents pales in comparison to the bloodletting the industry has experienced, due in some part to bare-boned risk management infrastructures.

Lest one think these initiatives are designed to address only the risk component of lending, I would offer that they also help return the community banker back to the successful production role of lending to a diverse borrowing base: a win-win.

*Another version of this article was previously published in Carolina Banker in 2009.

Delinquency rates tick upward: Blame the Government


pastdue.jpgConsumer delinquencies on loans moved higher in the second quarter of this year, as high unemployment continues to hurt the loan portfolios of banks, according to the latest analysis of the American Bankers Association.

As if you hadn’t heard the refrain enough lately: the country needs more jobs.

“The most important factor in whether or not someone can repay their debt is whether or not they have a job,’’ says ABA Chief Economist James Chessen, in the understatement of the year.

It hasn’t helped matters, as Chessen points out, that the national unemployment rate ticked upward from 9 percent to 9.2 percent during the second quarter. (The latest unemployment rate for September, released by the U.S. Department of Labor today, shows a 9.1 percent unemployment rate.)

The ABA survey of 300 commercial banks about their auto, personal, home equity and credit card portfolios found that nine out of 11 categories of loans had higher delinquency rates in the second quarter than the quarter before.  The exception was a slight improvement in credit card portfolios and mobile home loans.

The overall, seasonally adjusted, composite index rose 17 basis points to 2.88 percent from 2.71 percent in the first quarter. The ABA defines its delinquency rate as the percent of loans that are 30 days or more past due.

Interestingly enough, the private sector has been adding jobs quarter-to-quarter since 2010. It’s the public sector, pressured by low tax revenues, that has been shedding jobs this year and through much of last year. (The latest figures for September show this trend continuing.)

In an ABA chart that uses its own loan survey data and data from the Bureau of Labor Statistics, the delinquency rate starts to drop as jobs pick up in the private sector. But you can almost see the delinquency rate on consumer loans begin to climb slightly after a series of layoffs in the public sector.

payroll-chart.png

“(Governments) spent a lot (of money) and thought revenue coming from property taxes or income and sales taxes were going to continue at that level,’’ Chessen says. “But when property taxes started to fall relating to home prices and when income fell, and sales were off, their revenue fell quickly but their expenses were locked in. To get expenses back in line has meant layoffs.” 

Unlike the federal government, most states must balance their operating budgets and not spend more than they collect in taxes, so the layoffs seem almost inevitable.

It appears that this time around, the public sector is a real drag on the economy, keeping unemployment high even as the private sector tries to get its footing.

Twist This


america-money.jpgYour country needs you. Your country needs you to go into debt, that is.

Hoping to jumpstart a lackluster lending environment, the Federal Reserve recently announced “Operation Twist” to drive down long-term interest rates such as the 30-year fixed-rate mortgage while increasing short-term interest rates.

The idea, a much bigger replay of a 50-year economic program of the Federal Reserve during the Kennedy administration, is that the move will make long-term borrowing more attractive, which could encourage home buyers to buy homes and businesses to invest in job creation.  But will it?

Scott Brown, the chief economist and senior vice president for Raymond James & Associates, says the Federal Reserve’s $400 billion program of buying and selling U.S. Treasury securities is trying to get banks to lend more, possibly by squeezing the interest margins that banks depend on. This interest margin is the difference between the interest banks charge on loans and the interest they pay out for deposits. As their profits get squeezed, the banks could increase lending to make more money.

But will they?

“With banks in a much better position than they were three years ago, the Fed is betting that a flatter curve, and margin compression, will not cause undo strain, but instead lead them to make up the difference in loan volumes,’’ Brown writes in his weekly commentary. “We’ll see.”

The problem with such an approach is that there are few high-quality borrowers out there wanting to get loans, and the banks have worked hard to improve the credit quality of the assets on their books. The idea that they would stretch their underwriting guidelines to offer more loans is doubtful, and whether their regulators would even allow it is also doubtful.

What could really spur lending is for more high-quality borrowers to somehow come out of the woodwork looking for loans at record low interest rates. But many potential homebuyers can’t sell the homes they do have or take advantage of low rates to refinance as home values continue to decline. Freddie Mac announced this week that the average 30-year fixed-rate mortgage fell to a record low of 4.01 percent as of Sept. 29.

In contrast, the short-term, five-year adjustable -rate mortgage rate ticked up after the Sept. 21 announcement by the Federal Reserve from 2.99 percent to 3.01 percent. It has remained flat since then, according to Freddie Mac.

Whether all this will spur lending is another matter.

“We question whether this program can be successful because we believe the lack of borrowing and lending activity has more to do with other fundamental economic and regulatory conditions than it does with interest rates,’’ writes G. David MacEwen, chief investment officer of fixed income for American Century Investments.

He goes on to describe the Federal Reserve’s toolbox as “nearly empty.”

It may be that the Federal Reserve is in the same boat as the Obama administration: there’s not that much more it can do to incentivize a reluctant and hobbled private sector. The government would like you to borrow, but will you?

 

What Falling Home Prices Mean for Banks


skydive.jpgThe most recent S&P/Case-Shiller Home Price Indices declined 4.2 percent in the first quarter of 2011 on top of an earlier 3.6 percent drop in the fourth quarter of 2010. “Nationally, home prices are back to their mid-2002 levels,” according to the report.

If you are a connoisseur of home price data—and the countless expert predictions since the market’s collapse in 2007—you know that the housing market should have bottomed out by now and been well into its long awaited recovery. There was a slight rebound in housing prices in 2009 and 2010 due to the Federal Housing Tax Credit for first-time homebuyers, but that rally pretty much died when the program expired on Dec. 31, 2009. Now, housing prices are falling again like a skydiver without a parachute.

Recently I called Ed Seifried, Ph.D., who is professor emeritus of economics and business at Lafayette College and a partner in the consulting firm Seifried & Brew LLC in Allentown, Pennsylvania, to talk about the depressed housing market and its impact on the banking industry. Seifried is well known in banking circles and was a keynote speaker a few years ago at our Acquire or Be Acquired conference.

“We’re pretty close to a structural change in housing,” Seifried says. You, me and just about everyone else (including, apparently, former Federal Reserve Chairman Alan Greenspan) was taught that home prices always go up—sometimes by the rate of inflation, sometimes more—which made it a pretty safe investment. “That dream has pretty much been shattered,” Seifried continues. “The Twitter generation is looking at the European (housing) model, which is smaller and more efficient. Your home shouldn’t be a statement of your wealth.”

A broad shift in housing preferences could have important long-term implications for the U.S. economy, since housing has been one of our economy’s engines of growth for decades. What is absolutely certain today is that a depressed housing market is hurting the economy’s recovery after the Great Recession, and that has broad implications for the banking industry.

A depressed housing market translates into a depressed mortgage origination industry, which has significant implications for the country’s four largest banks—Bank of America, J.P. Morgan Chase, Citigroup and Wells Fargo—which have built giant origination platforms that might never again churn out the outsized profits they once did. In fact, I wouldn’t be surprised to eventually see one or two of them get out of the home mortgage business if Seifried’s structural change thesis is correct.

Community banks that lent heavily to the home construction industry during the housing boom are either out of business or linger on life support. But even those institutions that did not originate a lot of home mortgages, or lent heavily to home builders or bought lots of mortgage-backed securities are being hurt because housing’s problems have become the economy’s problems.

In a recent article, Seifried points out that for the last 50 years housing has contributed between 4 and 5 percent of the nation’s GNP. In the 2004-2006 period, that contribution rose to 6.1 percent.  In 2010, housing accounted for just 2.2 percent of GDP—and dropped to 2.2 percent in the early part of 2011. Seifried also estimates that the housing market accounts for 15-20 percent of all U.S. jobs when “construction and its peripheral impacts are weighed.”

“It’s difficult to imagine an overall economic recovery that can generate sufficient jobs to return the U.S. economy to full employment without a return of housing to its historical share of GDP,” he writes.

In our interview, Seifried told me of a recent conversation he had with a bank CEO who thought his institution was reasonably well insulated from the housing market’s collapse because it had made relatively few construction loans. But that bank still experienced higher than expected loan losses because of all the other businesses it had lent to that ended by being hurt by the housing downturn.

Indeed, virtually no bank in the country is immune to the housing woes because banks—even very good and very careful ones—require a healthy economy to thrive. The U.S. economy needs a strong and growing housing market to thrive, and that doesn’t seem to be anywhere on the horizon.

 

Do Strategic Plans Still Make Sense?


chess.jpgIn his 1980 song “Beautiful Boy (Darling Boy),” the late John Lennon wrote a line that captures the challenge common to strategic planners (and the rest of the human race) everywhere: “Life is what happens to you while you’re busy making other plans.”

It was relatively easy for community bank CEOs and their boards to make a strategic plan five years ago when the economy was booming and it wasn’t hard for lenders to put their institution’s money to work. Then “life happened” in 2008 when the U.S. economy tanked and the fuel that drove bank earnings through the middle part of the previous decade – commercial real estate – became too dangerous and unstable for banks to use.

While the U.S. economy has posted five consecutive quarters of GDP growth through the third quarter of 2010, it seems that many business borrowers lack faith in the recovery because loan demand remains slack. The commercial real estate market is still pretty toxic, and bank regulators have been putting pressure on a lot of banks to downsize their CRE portfolios anyway.

So what’s the plan when no one wants your biggest product?

One could argue that the regulators have been driving the planning process at many banks. “They have told banks to reduce [their] CRE [exposure] by ‘X’ percent,” says Michelle Gula, president and CEO at mrae associates inc., a consulting firm that works exclusively with community banks. “They’ll come down on you if you’re not in the zone where they want you to be.”

Gula makes the fair point that for many troubled institutions today, the “strategic plan” ends up focusing on an immediate problem that has come under regulatory scrutiny and must be fixed. “Now the strategic plan needs to be very targeted,” says Gula.  “You have to identify exactly how you’re going to get it done.”

And yet banks still must find a way to grow, and if they have been too reliant on CRE lending, that could require a change in their business model. How should they do that?

Back in the late 1980s I left magazine journalism to work as a speech writer at insurance broker Marsh & McLennan Inc. One of my duties was to write the annual business plan. (It sounds more impressive than it actually was. I was just the writer. Others were the thinkers.) Marsh’s strategic plan came together in what I would describe as a bottom-up process.  Every significant Marsh business unit throughout the country had to submit its own plan for the coming year and present it to senior management. Eventually this deliberate process yielded a company-wide plan that was a distillation of the best opportunities – and best ideas – from throughout the firm. In other words, Marsh’s local markets and individual business units drove its strategy. There were top-down initiatives as well. But Marsh never strayed too far away from its markets and the people who knew them best.

In this context, the only difference between Marsh and a community bank is that Marsh had many markets and a local bank just one. But this is exactly where Geri Forehand, the national director of strategic services at Sheshunoff Consulting + Solutions, says banks should be looking for new growth ideas.

As they moved away from CRE, several of Forehand’s bank clients have developed new industry or business niches based on opportunities in their markets. One bank has concentrated on property management companies, another has zeroed in on local governments and non-profit organizations, while others have placed more emphasis on trust and investment management as their customers shift from spending to saving. Often, it’s necessary for the bank to hire experienced lenders and relationship managers who understand the new business sector, although Forehand says this is a good time to hire talented people from other banks.

“You have to evaluate the market and what it’s going to give you,” says Forehand. “And you have to evaluate people and determine whether you have the right ones. Managing the human capital side is as important as anything right now.”

I would argue that given the many challenges banks face today, including the decline of the CRE market, strategic planning is more important than ever. Find a niche or specialty in your market that is underserved, develop a strategy for attacking that market, hire the necessary talent and go for it.

Life happens, but that’s no reason to stop making plans.