Has Lending Turned a Corner?

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One of the more depressing aspects of this long-running post-recession malaise has been the continued shrinkage of bank loan portfolios. Consumers and business aren’t asking for many loans, and many of the people who do ask aren’t getting any. That impacts the economy’s ability to grow, if businesses aren’t investing and consumers aren’t spending.

But loan growth seemed to turn a corner in the second quarter, and interestingly, small and mid-sized banks are leading the way, according to an analysis by investment bank Keefe, Bruyette & Woods, Inc.

Total loans and leases increased 0.9 percent in the second quarter, or by $64.4 billion, according to the Federal Deposit Insurance Corp. (FDIC), the first actual growth in three years. The government’s statistics include all FDIC-insured institutions, both public and private. Commercial and industrial loans (C&I) increased for the fourth consecutive quarter, by 2.8 percent, while auto loans rose 3.4 percent, the FDIC said. Credit card balances rose by 0.8 percent and first lien residential mortgages rose by 0.2 percent.  Loans for construction fell for the 13th consecutive quarter, this time by 7 percent.

A deeper look from KBW of publicly traded banks shows that mid-cap banks had the largest growth in loan portfolios. Large-cap banks saw total loan balances decline by 0.2 percent during the second quarter, while mid-cap and small-cap banks grew their total loans by 5.9 percent and 0.7 percent, respectively.

The investment bank and research firm reported:

  • Among the loan categories at mid-cap banks, C&I loans posted the largest quarter–to–quarter increase, gaining 13.9 percent.
  • Large-cap banks posted quarter-to-quarter loan shrinkage across all loan categories except C&I, which increased 2.0 percent.
  • Only Puerto Rico and the Southwest saw aggregate quarter-to-quarter loan shrinkage. Total loans fell 4.9 percent sequentially for Puerto Rico, and 1.6 percent for the Southwest.
  • The Midwestern and Southeastern regions posted the strongest quarter-to-quarter loan growth as total loans increased 9.5 percent for the Midwest and 6.1 percent for the Southeast.
  • Loan portfolios still are down from a year ago. On a year-over-year basis, total loans (excluding consumer loans) have declined annually for seven consecutive quarters, most recently falling 0.5 percent in the second quarter, according to KBW.
  • The commercial and industrial loan category, which accounts for 18 percent of total loans, is the only loan category to post both quarter–over–quarter and year–over–year loan growth of 2.7 percent and 4.6 percent, respectively.

Commercial and industrial loans to businesses clearly remain a source of strength, even as real estate is soft. The growth in loan portfolios among small and mid-sized banks is a welcome sign, even though large-cap banks account for 90 percent of aggregate loans, according to KBW. Banks have been giving investors something to be happy about: Higher profits, better loan credit quality and even some loan growth during the second quarter. But with the wild swings in the market and plummeting bank stocks lately, it may be that investors still are too worried about the economy to care.

The Loan Conundrum

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Steve-Trager.jpgSteve Trager is president and CEO of Republic Bancorp, Inc., a Louisville, Kentucky-based, $3.1 billion-asset publicly traded company with 43 bank branches in Kentucky, Florida, Indiana and Ohio. Despite the crummy economic environment, poor loan demand and high regulatory demands, Republic Bancorp has maintained high profitability; even with half its loans in residential mortgages, and most of the rest in commercial real estate, construction, business and consumer loans.

Republic Bancorp had the second and third highest return on average assets and return on average equity last year, and the fifth best performance overall in Bank Director magazine’s ranking of the top 150 banking companies in the nation.

To be sure, the bank has experienced problems, too.  Its non-performing assets are 1.28 percent of total loans as of the second quarter, a decline from previous quarters, and it took a $2 million charge in second quarter earnings over a civil penalty from the Federal Deposit Insurance Corp. relating to its IRS tax refund anticipation loan service.  (The company says it will contest the fine before an administrative law judge and will work to make sure its tax firm clients comply with applicable banking regulations).

Trager talked to Bank Director recently about how he’s handling the challenges of the current regulatory and economic environment.

Can you talk about what sort of lending you do?

The challenge for us in residential mortgages is we compete with a government product that is a 15- and 30-year fixed rate at 3.5 percent for 15 years and 30 years at 4.25 percent and only the government would make a 15- or 30-year fixed rate loan at those kind of rates, with that kind of interest-rate risk. We are proud to be able to offer that government product to our customers as well and we service that product as a competitive edge. Every single one of our products is delivered by a Republic Bank banker as opposed to a broker and that is competitive difference for us. We sell those (government-backed) loans on the secondary market so we don’t keep them on our books.

So what kind of residential mortgages do you keep in your portfolio?

There’s an expanding universe of people who aren’t able to comply with the government’s rigid requirements. Some of those requirements don’t reflect credit quality. Some folks are very capable with good debt service characteristics, low loan-to-value. They might want to buy a condo and the secondary market is very difficult for condos.

We would love to expand our offering to an even bigger group of customers who are very credit worthy, if we could get a little better pricing. The biggest risk today is regulatory risk. The mortgages we do, the rates we do, and whom we make them to, is just subject to so much scrutiny, that we can’t take a chance to expand our portfolio credit offering to those who need it.

Didn’t your $2.2 billion loan portfolio grow a little bit in the second quarter, by 2 percent?

Absolutely, (it grew) by about $50 million. That was a little bit more than half commercial and some residential. I think customers see Republic Bank and our financial health as a stable, long-term option.

We’re still in the market for residential mortgages because we have enough size and enough volume. The risks are so great that it has pushed a lot of other lenders out of the market. Any mortgage loan we make, we’ve got to gather tons of fields of demographic information, for thousands of loans per year. It frustrates customers.

Have you loosened your underwriting standards recently?

We have not. Our underwriting standards have remained relatively stable over the last five years. I do worry that in this market, where there is not much loan demand and a lot of banks in desperate need of loans that that’s a dynamic that might cause some to stretch their underwriting models. We’re never going to sacrifice the long-term viability of Republic Bank or our customers for short-term gain.

Your focus has been maintaining a highly profitable bank. You saw profits rise 50 percent in the first half of the year compared to the same time a year ago to $80 million. How?

I think it’s a combination of the stability that our core bank provides. We haven’t been haunted by credit quality. We have had good demand from both the deposit and loan side. It’s just trying to do the right thing over and over again for a long period of time, and having the right people do it. We’ve got 780 associates and they do a spectacular job.

We also have niche businesses that supplement our bottom line. We are the largest provider of electronic tax refunds in the country. We service folks like Jackson Hewitt, Liberty and other tax services around the country, processing electronic refunds for their customer base. A small percentage of the customers would like to get an advance on their refund within 24 or 36 hours. That represented about 700,000 of our four million tax refund customers in the first quarter.  For the rest, when the IRS pays it, we make sure our customers get it quickly.

What advice do you have for other bankers in this difficult time to grow lending?

Go out and encourage and support a good lending staff. Get out and pound the pavement. Our lending staff is very incentivized to do that. Their incentives are tied to loan quality. Part of their annual bonus is determined by production and delinquency. We are fortunate enough to have had a lot of folks who have been with us for a long period of time, and that helps.