Are banks the Burger Kings of lending?
In a bid to increase their loan volume in a time of little fresh demand, banks are competing for one another's customers mostly on price, so much so that many big players are generating less income even as new business loans are added through the dollar menu-like strategy.
The downward trend in loan income worries some observers because it challenges one of the industry's main strategies — cross-selling to a swath of new loan customers — for escaping the throes of the financial crisis. It also raises concerns about the quality of the loan underwriting.
"I think all banks are sacrificing a little bit on spread, and they can afford to," said Anthony Davis, managing director of Stifel, Nicolaus & Co. "A lot of banks have the attitude that, if we can get the customers in the door, maybe we have to use price right now to do that. The important thing is getting the market share."
Last quarter, commercial loan balances rose at Comerica Inc. and U.S. Bancorp. But both generated less income even as credit lines rose at Midwest manufacturers, Texas energy companies and other corporate borrowers. Commercial loan balances rose and yields fell at Fifth Third Bancorp as well. The Cincinnati company said corporate borrowers are paying off bank loans and also refinancing them at lower rates. Resurgent corporate bond and loan syndication markets are just adding to the competition.
These companies — so far — are seeing little payoff from aggressively extending new credit to large and small businesses with the aim of selling them other banking services when the economy recovers.
U.S. Bancorp, of Minneapolis, collected $4 million less interest on its business loans during the first three months of the year than it did in the two-day-longer fourth quarter, despite an increase of about $1 billion in business loans. That was the first time U.S. Bancorp made less interest on its nearly $50 billion commercial loan book since it began expanding it in the second half of 2010.
Comerica's commercial portfolio, meanwhile, stayed the same size last quarter, but the Dallas company also yielded less interest as derivatives it had used to manage interest rate risk on business loans last quarter matured. Spreads also narrowed on loans to large businesses with good credit ratings.
Executives at both companies said the plant expansion and working-capital lines that they are extending to small and large companies around the country will translate into higher loan and fee income eventually. In the first quarter, loan growth was a break-even proposition for both of them, at least in those portfolios. "They're not using them," Richard Davis, U.S. Bancorp's chairman president and chief executive, said in a call with analysts and investors last week. "We don't have anything to show for it right now on the loan balance sheet."
Lower yields on growing loan books is not a pressing problem — at the moment, market watchers say. Whether it becomes one depends on the direction of two things that nobody can predict with any certainty: interest rates and loan demand.
Rising demand for consumer credit would ease the price competition that's hurting yields on commercial and industrial lending.
But when will loan demand pick up? "I wish I knew the answer to that — all I can tell you is that the economy has got to look a little better and be more predictable," Dale Greene, executive vice president of Comerica's business bank, told analysts when asked that question last week. "We are starting to see some of that, but it's very, very modest."
An increase in short-term rates, meanwhile, would immediately improve yields on banks' commercial loans. That is because they tend to be variable priced using the prime rate or London interbank offered rate. Revolving credit loans also tend to mature in a year, meaning banks could reprice 2011's loans at higher rates next year.
Right now, banks have enough liquidity to make lots of relatively low-yielding revolving equipment and working capital loans, said Anthony Davis.
The costly certificates of deposits they used to raise capital as the as the economy tanked in 2008 are maturing, easing already low funding costs, he said. Problem-loan costs are falling. Yields on securities have stabilized after a volatile 2010. That means healthy giants such as U.S. Bancorp and Comerica are liquid, and willing to use low prices to win business around the country.
But, "at some point we have to have short-term rates pick up," Anthony Davis added. "And we have got to have a pickup in loan growth."
Brian Foran, an analyst with Nomura Securities International Inc., has concerns about the long-term meaning of what he described as the industry's current "pricing problems." Yields on C&I and auto loans are falling while yields on the stuff banks are running off their books like commercial real estate and construction loans are actually getting better, he said.
Regulators are wary of letting banks make property loans, so "everyone is moving in the same direction at once" in going after C&I and auto," Foran said. "Right now, few of these loans are going bad. But they're being priced so cheaply that they don't have a "lot of margin of safety."
In discussing earnings last week, Foran noted that Zions Bancorp. said it competed for a commercial loan deal it did not win that was priced at rate of Libor plus 90 points. That is strikingly low, Foran said; a year ago the market rate for commercial loans was around Libor plus 200 to 250 points. At the rate Zions saw, he estimates that loan would generate a yield of 1.5% or less — well below the 4% to 5% commercial yields most banks reported last quarter.
Foran said his fear is that bad C&I loans will start a new credit crisis in a few years.
"The fact that anyone would be pricing a loan at that level — how do you make money when you're charging someone 1% interest?" he said. "If this is where we are in 2011, what is credit underwriting going to look like in 2014? I think based on the trends we're seeing right now, it's really concerning."
