In this episode of The Purposeful Banker, Dallas Wells and Jim Young take a look at the reasons why commercial loan growth may be tough to achieve in 2021. But they also discuss ways in which banks can overcome those obstacles and grab market share in the coming months.
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Jim Young: Hi, and welcome to The Purposeful Banker, the podcast brought to you by Precision Lender, where we discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young, Director of Content at Precision Lender. I'm joined again today by Dallas Wells, our EVP of Strategy. And before we start, I want to let our listeners know that if they missed out on last Thursday's webinar on Precision Lender's newest products, market insights, and portfolio insights, they can still access the on-demand recording, and we'll have a link to that in the show notes.
So Dallas, let's actually start there with a look back at 2020, and we've talked a ton about how businesses were hurting, but banks were equipped to step in and help, but that Wall Street Journal article headline seems to imply that it didn't really work out that way. Why not?
Dallas Wells: Oh gosh.
Jim Young: I didn't mean to put you on the spot here.
Dallas Wells: Yeah, just right out of the gate. So 2020 felt like a decade in one year, so that's why the, "Oh gosh." If you go back to the springtime and you look at what happened on bank balance sheets, and in particular on the balance sheets of larger banks, right at the end of the first quarter, so right when all this mess kind of started in March of 2020, and then into April and May. There was massive growth on bank balance sheets, and specifically in CNI loan growth, and that was credit worthy companies accessing their revolving lines of credit, and in some cases accessing brand new credit.
But then for the rest of 2020, that loan demand just basically evaporated, and I think we'll get into it from multiple different angles, but to give the TLDR version, I think that many of the ... Again, we're talking about from a commercial perspective. Many of the commercial borrowers that had the wherewithal and the credit worthiness to be able to actually go tap the markets and borrow either found different sources, which we'll talk about, or they, out of caution, did not add a bunch of debt. So there just wasn't a lot of demand for debt.
Now there was demand for capital, but it was from businesses that were frankly, on the, no other way to put it, sort of on the brink of ruin because of the pandemic and economic restrictions and just all the stuff, and that's really where PPP came in. It was the lifeline, it was funds that banks probably wouldn't otherwise have been willing to lend out. And we did lots of data, lots of updates, on kind of where the market was, and at one point we put out a piece that was like, "Is the middle market, loan market frozen at the moment?"
Jim Young: Oh yeah.
Dallas Wells: And there was a time where basically, outside of PPP, there was no kind of on balance sheet bank lending happening. It did pick back up. Those markets did thaw a bit, but not enough to actually grow loan balances. You also saw just a ton of liquidity land in the marketplace, and we can talk about that some too. But lots of liquidity, lots of deposit balances in essence, some of those straight from the U.S. Treasury, some from other places, and that was used in aggregate to pay down debt.
So we actually saw kind of across the board loan balances drop in the banking industry, and this was not in the prior credit crisis of 2008-2009, because the banking system locked up, it was because there just wasn't a lot of demand for net new debt. And again, to oversimplify it, the economy kind of locked up and slowed down, therefore, there was not a whole lot of need for new debt to finance normal operation. So again, that's a gross over simplification, but that's what happened.
Jim Young: And I guess we should specify here too, from a staff's perspective, when we're talking about loan growth here, you mentioned balances, and so I'm guessing, and this is probably dangerous when the marketer comes in and starts trying to guess on this sort of thing, but all those PPP loans, we talked about the glut, the massive demand on it, that's, I'm guessing, more of a hey, if you looked at maybe the total actual number of loans you might see a rise, but because those loans were not big needle movers, it's not, it's something that really affected balance. Is that right?
Dallas Wells: That's right, and I think that gets a little bit into the PPP topic that we'll have to talk about. There was really very different activity at kind of the different ends of the spectrum of the commercial loan market. So on the small end, everything became PPP, right? So either those businesses either didn't want that credit or were not worthy of credit and where there was funding to be had, it was PPP. And then at the bigger end of the market, those companies again, either didn't need or want the money, or if they did need or want it, they went out and found it somewhere else because it was cheap and they could go out and access bond markets and do capital raises in a much different way.
Jim Young: All right. Well, you slightly stole my thunder here on my next question there, because I was just about to say, "Well, where do you mean, what else?" But you already said it. Because the Wall Street Journal mentioned a bond boom, and companies, instead of taking out those loans, just issued debt that investors could buy up. Okay, it makes sense to me, and again, as the non banker marketer here, I guess, why was that more prevalent in 2020 than previous years? I mean, it's obviously an option you can always choose if you're ... Well, if you have that option, you can always go with it, so why more prevalent?
Dallas Wells: Yeah. More prevalent just because it was borderline free money, so rates dropped across the board. And again, if we look at it from a macro perspective, essentially the Fed fired up the printing press.
Jim Young: Yes.
Dallas Wells: So injecting infinite liquidity and maybe just as important, the trick they learned from the financial crisis, the promise of infinite liquidity. So it's one of the great quotes from the financial crisis. It was the Hank Paulson quote of, "If you have a bazooka in your pocket, you don't necessarily have to use it. Just everyone has to know that you have it."
The Fed has made clear through the last crisis and through this one that liquidity will not be the ultimate issue. They will make sure that there is liquidity in the works. So they spun up all kinds of new funding mechanisms, they renewed some asset purchases, they reduced the short-term borrowing rates. So what that results in is low interest rates across the yield curve and investors of all kinds with just gobs of liquidity and out there desperately seeking yield, which means any credit worthy borrower of any size out there now had this possibly once in a lifetime opportunity to issue debt really cheaply.
So those that accessed those revolving lines of credit in the spring, if we give a hypothetical use case, if you are a medium-sized, a large corporate borrower, and you have a $50 million revolving credit facility, things looked really ugly in March of 2020, so you access that revolver and you pull down the $50 million bucks. Then you wait. Interest rates get really cheap, the financial markets remain open, there is investors everywhere, willing to loan you money really cheaply.
You can basically refinance that $50 million revolver into almost perpetual long-term debt at near zero rates, and you have your credit line back fully operational and open. So you just sort of ... There was gobs of new debt, but it didn't land with banks. Banks kind of have this ability to provide quick, overnight liquidity, but the longterm embedded debt stuff, those larger corporations tend to go to the bond market and they had a great opportunity to do so.
Jim Young: All right, I'm going to go ahead and timestamp this one because I'm going off script with this next question, which means it's very possible that we're going to go back and ...
Dallas Wells: Fair enough.
Jim Young: Not including this one. You're telling me this and I'm sitting here saying I get it from a larger national economy standpoint, but from a banking standpoint, it feels like if you have infinite liquidity, then sort of some of the valuable that banks can provide is diminished, I would think. Because you're usually standing around and saying, "Hey, you need money? I've got money." So in some ways, and again, I don't want to make it sound ungrateful, but in a way, did that hurt bank's ability to essentially produce profit?
Dallas Wells: Yeah. The banks have in many cases been sort of the backstop, right? The place to go for that liquidity, and that wasn't necessarily needed this time. So borrowers didn't have to go to their bank to access the liquidity. If they were small, they went to the PPP program through the banks, but that was a government program to get money that way. If they were large, they went to the bond markets. The banks were largely left where they were facilitators of both, so they did generate fees from placing those bond deals. They are generating some fees from placing the PPP money, but it didn't stay on their balance sheets. What they did get though, and what is still there as a challenge is all the deposit balances.
Jim Young: Yeah.
Dallas Wells: So stimulus checks, those exact PPP loans that they did. What most businesses did with those is they said, "Thank you for the funding. I'd like to deposit this into my checking account and sit there with it. Just like leave it be." So banks are in many cases sitting there with at best zero net spreads on those, in some cases, negative spreads on that money. The tricky part of operating a bank balance sheet is you don't know how long those new deposits will stick around. Is this a temporary phenomenon or is this caution, will it be with us for a few years?
And so you don't know how to invest those balances. Should you aggressively go loan them out? Should you invest them into a securities portfolio? Can you invest beyond a couple months? It's a really tricky thing for kind of the treasury function of the bank to try to figure out and therefore, for the bank to know what sort of appetite do we even have to go aggressively loan money. Right now it feels like we're drowning in this liquidity, but is it permanent or is it very much temporary and we just need to sit tight?
The quarter to quarter earnings right now are suffering accordingly. The last time we saw this was after the financial crisis, there was a similar influx of deposits. They stuck around for a decade, so that's the tricky part for management teams to wrestle with right now.
Jim Young: All right. Okay. But having said that, we have put 2020 behind us, 2021 is here, we have a vaccine, I might be able to take an actual vacation this summer. We talked about, in one of our previous podcasts, about the hotel industry and how hotel loans and what a dicey thing that was.
Dallas Wells: Yeah.
Jim Young: Maybe that sort of is turning around. You got to think a bunch of businesses that have been, as you mentioned, frozen are thawing out now, but then looking at for the American Banker article, they put in a survey put out by ... I'm going to botch this pronunciation, Cerebro Capital, where they said only about 46%, a little less than half of commercial bankers surveyed, expect commercial loan growth demand to strengthen. And I guess, is part of that because like what we just covered, like people are going, "Well yeah, I need some money but I can get it from these other sources." Or is there something else at work here that are making commercial bankers go, "I don't know if we're going to get loan growth this year."
Dallas Wells: Yeah. So first of all, I'm going to go with the assumption that since I've been watching some of the X-Men movies with my kids through the necessity of staying home that that's Cerebro Capitol.
Jim Young: Cerebro.
Dallas Wells: Again, I could be equally as wrong there.
Jim Young: It does sound like a superhero name though, right?
Dallas Wells: Yeah.
Jim Young: Or a villain. I don't know.
Dallas Wells: Yeah, that's what we'll call it. We'll go with that. I think bankers are not seeing any evidence of new loan growth, right? They can't yet see it on the horizon. So again, their borrowers, that would be the ones that they would be comfortable that would actually be qualified as bankable for typical bank credit terms, they don't need the money or they don't see projects worth investing in at the moment, right? So your real estate developers are probably not breaking down your door to go start new projects right now, they're probably waiting to see what happens. Your really strong companies are, outside of real estate, are probably pretty flush at the moment, again, going by the aggregate numbers.
And so there's not a ton of demand, and again, where there is demand, we have to look at once again, those two ends of the spectrum and for the small ones, there's another round of PPP. You're talking about either money that is forgivable, so therefore, it's a grant from the government. Or if it doesn't end up being a grant, it's at 1% and super flexible, forgivable, easy terms. That's pretty hard to compete with and banks don't need to compete with that. And on the big end you've got once again, the bond market at super cheap rates.
So there's just not a lot of ... Commercial banking has become in all reality, kind of, in the grand scheme of things, a niche business, because you're looking at borrowers that are kind of a particular size, of a particular credit worthiness. That particular type of borrower right now doesn't need a whole lot of money from you, but your depositors as a whole are pretty flush. So loan growth is in that window, in that narrow window that banks operate in, is going to be really, really hard to come by.
Jim Young: All right. In that same survey, they mentioned 73% of non-bank lenders expect their demand for commercial loans to strengthen. So I'm not quite sure, to be honest, who are the non-bank lenders we're talking about here? The grammarian in me points out that you can either be a bank lender or a non-bank lender, and that literally covers everything.
Dallas Wells: Everyone else, yeah.
Jim Young: Yeah, literally. If you're not a bank lender, what else would you be but a non-bank one? But what are they talking about here, because I wasn't assuming that was bond market stuff here, so I wasn't sure what they were talking about.
Dallas Wells: Well, I think if you just look at true volume here, this is going to be some combination of bond markets, investors like insurance companies, private equity, there are a fair number of dollars out there attached to those, and then what probably, at least in terms of publicity maybe out punches their real weight would be the Fintech non-bank disruptors here.
So they are players. They are issuing debt, but not on the scale anywhere near those other options, the bond market and sort of insurance companies and private equity and whatever, other outside investors. So it's a pretty broad category. There are trillions of dollars available for corporations to borrow out there between those and fintechs maybe make up an outside portion of that survey, but not as many of the dollars actually being lent out, if that makes sense.
Jim Young: Okay, gotcha. Yeah, so I was curious about what is that slice of the pie there? Although again, if you're throwing in ...
Dallas Wells: It's big. Yeah, if you include all that other stuff, it's big. If you just limit this to kind of banks versus fintechs and/or challenger banks or whatever terminology you want to use there, that's not as big and it's a growing number, there's no doubt about that, but I don't think that's the number yet that keeps bankers up at night. And when we talk to bankers and relationship managers that are in the trenches every day, fighting for individual deals, what they talk about running into is these deep pools of capital from an insurance company that is willing to do long-term deals, covenant light, pretty loose credit standard kind of deals because they can't find yield anywhere else. What are they going to do? Go buy 10-year treasuries at 1%, 30 year treasuries at sub two? I mean, there's limited options for them, and so they see these commercial loan markets for really strong borrowers at LIBOR plus 180, that's not so bad. They'll take that.
Jim Young: All right. So then I think you may have sort of explained to me sort of what's happening because the Wall Street Journal article pointed out that net interest income fell 5% last year. This one was the biggest drop in more than 80 years of record keeping. Yikes.
Dallas Wells: Yeah.
But then that American Banker article
says hey, competition for CNI is going to lead to looser credit standards, which seems like not what you're looking for coming off of that. But it seems a bit unavoidable, I guess.
Dallas Wells: Yeah, it's too many dollars chasing too few deals.
Jim Young: Right.
Dallas Wells: And so what ends up happening is the spreads get tighter and tighter and the standards get looser and looser. This is ...
Jim Young: Bad combination.
Dallas Wells: Classic cycle.
Jim Young: Yeah.
Dallas Wells: Yeah. I think the initial expectation when sort of the markets for a very short while sort of locked up last spring, it was the expectation that the opposite would happen, right? That spreads would widen.
Jim Young: Right.
Dallas Wells: That standards would get tighter. Bankers would sort of clamp down on all kinds of stuff. And that was the case for a short while, and I think bankers are still, and from a credit perspective, being cautious, but there's kind of two different flavors of credit standards. One is how many deals do you say yes to versus how many deals do you say no to? And I think those credit standards have tightened where there's more deals that you say no to, but for the deals that you're willing to say yes to, you're probably willing to get a little looser around the edges for those.
And so those two things are diverging a little bit. The strong credit worthy borrowers out there can really name their terms right now, both in terms of credit spreads and pricing, and also just structure and covenants and they can shop those deals and find plenty of willing takers. So I think that's one of those things where when you say is credit tighter, that's probably too broad of a question because it is, but not for those credit worthy borrowers.
Jim Young: Okay. All right, and I promise we don't start off all these conversations, at least I don't go ... Planning to go through a depressing litany of statistics, but sometimes it seems like we end up there.
Dallas Wells: Yeah.
Jim Young: But I always like to try to take it a point here of let's talk about sort of what's the viable way forward here on this for commercial banks that are, maybe it's not growing commercial loan books, but keeping ... Holding the fort here and not trying to give away the store in the process. So I mean, what's your feeling if you're sitting at a bank right now and you've had a discussion around a boardroom, a virtual boardroom, with people about here's the situation we're facing, what's some of the, I guess, strategy going forward to say that we can do something that's not just cut costs, I guess. Or maybe that isn't, I don't know.
Dallas Wells: Yeah. So here's the thing as we've dug into even the performance of our own client base and their peer groups, right? So we get pretty granular with that look at the industry. What it shows you is that always the averages are a little misleading, right? So the industry on average saw loan balances decline, saw net interest income decline, and as a whole this maybe a little bit of a depressing story, but that is not a universal truth. And we saw from some of our clients last year, commercial loan growth north of 20% and credit spreads that actually widened a little bit.
Jim Young: Yeah.
Dallas Wells: So what it shows us is through tough times like this, this is where banks are actually able to really differentiate themselves, and we see lots of different kinds of strategies lead banks there, but I can tell you that it is always an intentional strategy. So being purposeful and intentional about these are the industries that we care about, these are the types of customers we care about. Some of the community banks we've seen have really embraced the sort of local we're in this together sort of everything from marketing approach to actually putting dollars out in the street that line up with that.
But there are banks who have done really, really well, and there are others who are getting their butts kicked right now, and there is no universal truth, there's no silver bullet, but there are banks that are seeing that hey, right now is tough and it is either some that have really good relationships, a really good understanding of certain industries, certain borrowers, they are truly trusted advisors. Everybody says that, but there's a few that actually pull it off.
Jim Young: Right.
Dallas Wells: And also there are some banks that have done a really good job of making themselves digitally accessible and others who have not.
Jim Young: Yeah.
Dallas Wells: So the reality is that there's a whole lot of banks who have reduced lobby hours, who have bankers that are harder to get ahold of, and their website and digital channels look exactly the same today as they did 15 months ago. And there are others that have spent the last year, we've talked about it a little bit, doing 10 years worth of digital transformation in 12 months' time.
Jim Young: Yeah.
Dallas Wells: And really just jumping eyeball deep into this, and they're accessible, right? They're reachable and they are taking market share. So this is one of those opportunities where the banks that are willing to jump in and invest or are reaping the rewards from it. So I know you and I have talked about, we've got a little bit of ... We got a couple of projects going where I think we've got more to come on talking about some individual banks and kind of how they go about making money, what sort of customers are important to them, what sort of strategies are important to them.
Jim Young: Yeah.
Dallas Wells: I think this is really interesting and really timely and something that we can dig into a little bit in the next couple of months.
Jim Young: Yeah. And again, it's an inadvertent teaser, but that's sort of the concept of if you want to look across super broad averages and stuff, you may find this, but if you can take a deeper look into it, you can find pockets of hey, this part, there's some profitability here.
Dallas Wells: Yeah, there is some opportunity out there, so that's what we'd like to talk about is let's shine a light on a few of those and see what's working for some of the banks that are doing well right now.
Jim Young: All right. Well, once again, Dallas, you brought me all the way down, but then you pull me back from the brink at the end of the podcast.
Dallas Wells: Right at the end.
Jim Young: Right at the end, yep. All right. Well, that will do it for this week's show. Dallas, again, thanks for coming on.
Dallas Wells: You bet. Thank you.
Jim Young: And thanks so much for listening. And now for a few friendly reminders, if you want to listen to more podcasts, check out more of our content, visit the resource page at precisionlender.com or head over to the homepage just to learn more about the company behind the content. If you like what you've been hearing, please make sure to subscribe to the feed and Apple podcasts, Google Play, or Stitcher. Love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young for Dallas Wells, and you've been listening to Purposeful Banker.
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