Magazine article Business Credit

RMA Lending Outlook for 1995

Magazine article Business Credit

RMA Lending Outlook for 1995

Article excerpt

Last year is fading into banking memory as the year too many of us bankers chased too few borrowers, and 1995 is materializing as the year more and more of us would like to forget. Squeezed between price competition and the rising cost of funds, we bankers are sacrificing our profit margins as our borrowers push us harder for no-string loans. These kinds of loans are the high-risk deals that made the last recession so painful. If there is no profit reward for taking these risks, the penalty looming ahead is likely to be another round of losses for us bankers.

Just last fall, Fed Chairman Allan Greenspan warned the banking industry that it remained an open question whether current loan standards were adequate. He noted that the riskiest borrowers were not being charged sufficiently high rates to cover their significantly higher risk of default. Moreover, the Options Clearing Corporation's (OCC's) Gene Ludwig has observed signs that some banks have eased underwriting standards over the last several quarters.

The signs that Mr. Ludwig and Mr. Greenspan read include a Federal Reserve quarterly survey that tracks bankers' observations of so-called underwriting standards such as the direction of loan-to-value ratios for collateral, the requirement for guaranties, and the trend in debt service coverage ratios. The latest (January 1995) survey continues to report an easing trend in credit underwriting standards that spans the past several quarters.

According to an analysis of the survey data conducted by RMA's Agency Relations and Research Unit, most of the easing can be found in big corporate loans, and less so in smaller business loans. The RMA analysis, published in its Hot Topics newsletter, points out that the easing begins with just a few institutions in the nation's markets, but that other lenders are usually forced to loosen their standards just to keep their customers.

To the outside world - and especially borrowers - these concerns over loan covenants seem exaggerated. However, these standards underpin loans through economic downturns, and the next one is not all that far away. When top regulators like Chairman Greenspan and Mr. Ludwig express caution over credit standards, bankers know that the Fed and OCC examiners also will be expressing similar concerns.

Bankers Court Small Business

So bankers have been looking for ways to boost the reward for risk; one of the hottest opportunities has been the small business market. Many banks have redesigned their lending processes to accommodate the faster response times and lower documentation requirements that smaller businesses expect. Smaller business borrowers do not have or need all the sophisticated financial reporting of their Fortune 500 corporate big brothers. Tax returns and financial statements are more the rule than audited annual reports and 10-Ks.

So how does a bank lend to a business when its tax returns are on extension and the personal statement omits the spouse's holdings of jointly owned assets? Bank installment lenders have been making loans to smaller businesses for years without much more than a credit bureau report and some limited income information. Somewhere down there in the under $50,000 loan range there are a lot of small business operators who have been looking for credit in all the wrong places (by using 30-day revolving charge cards to buy equipment and substitute for start-up capital, or borrowing from marginal creditors at usurious rates to pay their bills).

By drawing upon the successful credit scoring techniques pioneered in consumer banking, banks have begun to employ credit scoring for business lending. …

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