Competition for commercial loans driving down interest rates and bank margins
It’s a borrowers’ market with too many lenders chasing too few strong loans, according to a survey of senior loan officers conducted by the Federal Reserve Bank Board in April.
The Fed survey revealed that many banks were easing standards on commercial and industrial loans and many of those respondents cited increased competition as the reason for doing so.
While this was a national survey, the findings hold true here in Illinois, according to Linda Koch, president and chief executive officer of the Illinois Bankers Association.
“There’s not a lot of new loan demand in Illinois,” Koch said. “It’s been improving but there is still a lot of uncertainty among commercial borrowers. That can be attributed to the poor economy, the fiscal crisis of the state of Illinois and the uncertainty that’s out there regarding their (business owners’) current costs, compliance costs and future costs like health insurance.”
One issue that’s a big contributor to the lack of loan demand but that doesn’t get a lot of recognition, according to Koch, is the need for real estate appraisals. She says that today every loan – whether it’s a new loan or a loan renewal – requires a new appraisal. Prior to the financial crisis of 2008 and the subsequent Dodd-Frank Wall Street Reform and Consumer Protection Act, it was possible for banks to rely on appraisals that were as much as five years old. That, she says, is no longer the case.
“We all know the value of property is not what it used to be five or six years ago and commercial borrowers are cautious,” Koch said. “They’re nervous that the value of their collateral or property isn’t what it used to be and so they’re approaching things very cautiously when they’re expanding, growing their business or opening a new business.”
There are still high-quality, financially credible commercial borrowers out there, according to Koch, but there are fewer of them; and those who fit that category are approaching expansions cautiously.
“Buyers are looking for the best deal,” Koch said. “And with interest rates the way they are, they’re shopping and they are absolutely shopping for the best deal. Illinois is home to more banks and branches than virtually any other state in the country, so there are a lot of options for the borrower, a lot of banks to choose from – not to mention non-traditional bank options that are out there as well.”
Another factor that’s spurring lender competition, according to Koch, is that banks are flush with cash. Consumer savings rates, she says, have increased substantially since 2006, and that provides a lot of money for banks to lend. Consumers and business owners are still in an accumulate cash mode, egged on by the uncertainty in the economy.
“Not every bank is well capitalized,” said Koch, “but the vast majority of banks in Illinois are very well capitalized. They have a lot of liquidity, they have a lot of money to lend and they are waiting for the opportunity. They’re ready to lend. We couldn’t say that five years ago when the crisis first hit and banks were setting aside a lot of capital to insure themselves against loss.”
Brad Rench, regional president of First Mid-Illinois Bank & Trust, says the shrinking loan margin environment is making life difficult for banks that subsist solely off loans and deposits. He says First Mid-Illinois Bank has a broad range of products it can offer to business customers: trust services, wealth management, farm management, brokerage and insurance. This full complement of business services, he says, not only helps make the bank a better partner to the business owner but also helps the bank navigate through this low-margin, interest rate environment.
“It’s going to be harder for banks to survive just off loans and deposits due to the huge competition and shrinking interest margins,” Rench said. “Banks that have strong non-interest income will be better positioned to compete in this tough environment.”
Rench has been in the banking business for more than 30 years. Over those three decades, he says, he has not seen interest margins below 3 percent – but they are coming close now.
“It’s going to be tough for the banks to operate on those kinds of margins,” Rench added, “because one bad hiccup and they’re in trouble.”