During a recent audioconference held by RMA–The Risk Management Association, community bank lenders from around the country discussed the lending and credit issues of most concern to them during the next 18 months.
Philadelphia, Pa (May 17, 2001) As the economy softens, problem loans continue to rise. Community banks are most likely to feel it in their real estate portfolios where most have a strong niche. Agriculture, small business and consumer lending portfolios are also affected.
During an RMA audioconference held in April, four community bank lenders representing a cross section of the country, expressed concerns about a softening economy, particularly in real estate. Liquidity and loan funding continue also to be challenges for small bank lenders because deposits have not kept pace with loan growth.
RMA Chair William Scholl, who is also president and CEO of Pulaski Bank and Trust, Little Rock, Arkansas, cautioned community banks to stay away from sub-prime lending because "it's a narrow niche that can turn on you in a hurry."
He also cautioned his colleagues about enterprise value lending. Enterprise value lending is a loan that is based on the value of a business as a going concern rather than its collateral value.
Consumer lending is a particular concern. "Bankruptcies are on the rise and the average consumer is significantly over leveraged," said Scholl. "How that will affect the commercial side is still unknown."
Funding continues to be a concern for community banks across the country. Many economists forecast that the Federal Reserve will continue to cut interest rates with the Federal Funds rate predicted to go as low as 4 ¼% by fall. "These rate cuts continue to narrow our spreads to some degree because we can't lower our liabilities quickly enough," says Scholl, whose $300 million bank earns a significant part of its income from fees.
Anita Robinson, president and CEO of Mission Community Bank, San Luis Obispo, California, says her bank, a 3-year-old $68 million institution is seeing an increase in delinquencies, mostly in their small business portfolio. Although the bank's growth has been steady in this rural area between Los Angeles and San Francisco, Robinson said, "We are starting to see problems arise in some of the more leveraged credits and some bankruptcies as well."
She predicted that energy problems in California will have "a substantial impact" on all California banks. "Our borrowers are seeing significant increases in costs. Some will have to deal with shutting their businesses down during energy blackouts."
Yet Robinson believes the economy remains strong. Real estate prices have continued to rise in most of California. Dot.com layoffs in the Silicon Valley may have an impact on inflated housing costs there, she said. She also keeps an eye on what happens in the Pacific Rim countries that import California produce.
Meanwhile, energy prices are taking a toll on the economy of the nation's heartland, already suffering from low commodity prices. In Grand Island, Nebraska, the economic outlook is bleak. "Our gasoline prices have gone up 30 cents per gallon," says Rick Harbaugh, president and CEO of Equitable Building and Loan Association, a Federal Savings Bank, a $135-million institution. "There's a shortage of natural gas products for irrigation, for drying at the end of the crop season, and for simply running the tractors across the field. The cost of production has outpaced the cost of the commodity prices so it's very difficult to balance."
On Maryland's Eastern Shore, National Bank of the Rising Sun a $100 million rural bank, is also experiencing agricultural issues and real estate issues. "Our area went through a construction surge because it is located within commuting distance of Wilmington, Delaware, and Baltimore where builders are running out of available land for residential development," explains Jack H. Goldstein, president and CEO of National Bank of the Rising Sun. "However, we are seeing a softening and some credit risk issues in construction as major employers such as Chrysler announce significant layoffs. Unemployment rates have gone from 4% to 9% in our county."
Agriculture also is softening on the Eastern Shore. "Milk production prices were down last year, causing problems for the dairy industry and we're just now feeling the effects of that," said Goldstein. "As farmers gear up for crop development, they don't have the working capital to support it. Transportation companies are affected as well because farmers are not able to pay for the movement of goods."
All these factors are creating pressure on marinas where there is a decrease in demand for loans. "Due to layoffs, people don't have the discretionary income to buy boats or second homes in our area or to support marinas. Some marinas are having trouble filling up and leasing space."
Banks in the Mid-South have not yet suffered too greatly yet as a result as a result of the softening real estate market. "We've had more residential foreclosures in the past six months that we've had in the past six years. Commercial real estate has not yet been affected significantly, but we know eventually it will."
Real estate remains a staple of community bank lending, however. As they lose consumer loans to big banks, small banks turn more often to real estate lending-creating concentrations that worry regulators. "It's a significant risk," says Goldstein, noting that the majority of community bank assets are invested in various types of real estate. "But over the past years we've become pretty good risk managers, and we've taken steps to protect ourselves." Goldstein says his bank looks closely at loan to values and makes certain that customers' cash flow can continue to support their real estate loans.
Agricultural land values in Nebraska have not dropped significantly yet, but they have never gotten back to the inordinate highs that they were in the early 1980s, said Harbaugh. "The value of a property, especially in agriculture, is only worth what its crops can produce in cash flow. Community bank lenders learned in the last downturn that cash flow pays the operating loan rather than the assets that secure it. Banks in this area do not offer high loan to value ratios on real estate because we remember when irrigated crop land cost $3,000 an acre. At the end of the last downturn, that same acre was selling for $800 to $1,200. Lenders paid some pretty expensive tuition to learn that lesson and they remember it well."
RMA is the only financial services association that specializes in promoting effective credit risk management practices across the entire financial services industry. Its membership consists of more than 3,000 financial service providers. These institutions are represented in the association by more than 18,000 commercial loan, credit, and risk management professionals in 50 states, Puerto Rico, Canada and numerous foreign cities, including Hong Kong, Singapore and London. For more information, call Pam Martin, Director of Regulatory Relations and Communications, at 215-446-4092.