In this week's episode, Jim and Dallas discuss recent commercial line of credit utilization numbers. What's happening with them, and what do they tell us about how companies are faring right now?
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 Jim Young, director of content at Precision Lender and I'm joined again by Dallas Wells, our EVP of strategy. We're continuing with our new cadence of doing The Purposeful Banker podcast weekly instead of every other week because again, current events are impacting the market so rapidly. So we're aiming to tackle a hot topic in commercial banking with each podcast, tell you about what we're seeing in the Precision Lender commercial pricing data set and discuss it in a way that gives you information that's as timely as possible. But again, given turnaround times with editing, things may shift between the time we record. This was on Tuesday, April 7th and the time we put this out, which will be Monday, April 13th so just keep that in mind. All right. Disclaimer out of the way. On to today's topic, line of credit usage. And Dallas, let's start off with why this topic, why is this [inaudible] we're discussing in this week's podcast?
Dallas Wells: Yeah. So it's related to a topic we've covered of deposit balances and looking at levels of cash within customer accounts and line of credits is looking at a similar thing of are we seeing cash flow impacts and utilization of a revolving line of credit is a pretty good proxy for that. So as your customers run into trouble, of course they draw out their lines to help fund that. And so some interesting things to come out of that in terms of what's happening in individual pockets of the marketplace there.
Jim Young: All right. So overall usage numbers that we saw when looking at that data, I guess first off, what are they? Or maybe let me rephrase this. What did you expect to see when you looked at the data and then how did that compare with what you saw when you took a look?
Dallas Wells: I think just from the fact that we essentially hit the off button on the economy for a couple of weeks and most of banks' customers, their revenue just stopped. I think what we expected to see was that line of credit utilization would be up. And I think that would have been confirmed by what we've seen with the paycheck protection program, the PPP loan program that's out there, just the overwhelming massive demand for that is saying that businesses desperately need cash and liquidity. So we expected line of credit usage to be up, perhaps materially up from prior weeks.
Jim Young: And so I guess what I'm wondering is does, I don't have the percentage in front of me, but did what we find match that or was it more or less, I guess?
Dallas Wells: So if we just look at the overall average, and so that was the first thing that we took a look at was just compile thousands of lines of credit from across our 150 clients and say, okay, on average, what's the committed amount and what's the current balance of those things? And you can chart it out and there is an increase, but it's not a huge increase. And so the overall number is basically those utilization rates since beginning of the year have been around 35, 36% utilization and they went up to over 38 so it sticks out. You can see the bump in the chart because those are typically fairly stable. There's a little bit of seasonality but not a ton. But frankly I expected it to be bigger than that. But this is really one of those things where an average like that is really misleading because when we looked under the hood of what was driving that, the average was barely changed but there was a whole lot of noise underneath that.
Jim Young: So what does that mean when you say a whole lot of noise underneath?
Dallas Wells: Just meaning even as we looked at individual banks, individual client banks, of course I won't name any names here, but it's interesting when you start looking at it that way. Different banks clearly handle their revolving lines different ways. So as we started the year, we saw utilizations at individual banks that ranged from some of them in the 20s, low 20s to some of them in the 70s. They just tend to size their lines differently and they have different sorts of customer bases, different parts of the country, et cetera. But wherever their baseline comes from, some of them have just been steady.
I'm looking at the top bank on my little table here, 62% utilization at the beginning of the year, 65% utilization now, so up a little but they've had bigger fluctuations than that just through kind of normal stuff. But here's one that was in the mid-50s. It's now above 80 for a different bank. So you see individual banks where they are definitely lots more cash out the door. Their customers are drawing on those lines. And what we don't know is, is that the bank's handling it different, is it their customers being impacted differently? Hard to know for sure but definitely some interesting differences from bank to bank there.
Jim Young: Yeah. And we're going to get a little more granular in how we look at that because what I was just thinking was is depending on what bank that is, for example, if that bank is spoiler maybe in Texas or dealing with customers in the oil industry, then maybe that LOC percentage is going to be higher. One of the things we, you mentioned about how they size the LOC and we did take a look at that, put them in basically three tranches and I'll just go ahead and my little two cents. I thought that the smallest group, and I think it's around zero to $250,000 LOCs, actually had the lowest increase and again, layman here, but I thought it would be the opposite. I thought that would be the smallest business and we're talking about SBA PPP stuff. Those would be the people really looking to, hey, I've got to make payroll next week, I've got to get cash on hand right now. But that wasn't the case at least by the percentages. Were you surprised by that?
Dallas Wells: Yeah. You weren't the only one surprised by that. And again this is just like it's an unprecedented set of circumstances.
Jim Young: One possible theory I had was is it possible that if it's a small business owner, you look at this and you're getting ready to, you got your finger on the button to push to go for higher usage of your LOC and then suddenly you find out about the PPP program and you say, well actually maybe I'll just do that instead, is that a possibility?
Dallas Wells: That's a possibility. I still would have expected some line of credit usage. But I think that has to be a contributing factor is that those smallest customers are the ones that are most squarely going to fit into the PPP. And why take on that debt yourself if it may be forgivable through this program? That said, it was announced, it took the government a while to get the program put together, which they did the night before it went live and then the banks have been trying to scramble to get it put together. And then with all the volume, we've written about this, but there's issues with the SBA systems and so all that to be said, I think it was announced but I don't know how much money's actually in the hands of small businesses yet. So what is interesting though is just anecdotally talking to some of our bankers and in what we're reading out there, I think a lot of things are just truly stopped to the point where the businesses are saying look, I'm having no revenue coming in.
I'm not writing any checks either. We're just literally going to pause. I'm not paying my rent. I sent the employees home I could send home and so I don't need to draw on the line. I'm not going to put myself on the hook for something that whenever things go back to normal, we'll square it up then. So I think we probably saw some of that on the smaller side of those businesses just throwing up their hands and saying I'm not doing anything. And I don't think the bigger businesses really have the same agility and that same option to just turn off the spigots. There are obligations that they simply have to meet. They've got these big revolvers in place for exactly these sorts of things. And so they just drew them down early and we're ready to weather the storm.
Jim Young: Right. Got it. And one thing I should mention as we're talking about these numbers and you may be listening and saying what are those numbers, that we're speaking to a blog post that at the time of recording is in the works but will be published by the time this podcast comes out and we'll have a link to it in the show notes. So if you want to follow along and look at the charts and the numbers that we're discussing, you can do it there.
Dallas Wells: And well-played there, Jim. I like how you just locked me into finishing that in time now.
Jim Young: 100%. 100%. I gave you time though. I didn't say it'll be done on Wednesday morning. By the way, you mentioned the way they were putting together the PPP program the night before and that sort of thing. And I thought that's kind of similar to the way we put together our podcasts and blog posts.
Dallas Wells: Yeah, same process.
Jim Young: So I can appreciate that sort of. Yeah. Exactly. All right. So we talked about size of LOCs. Going back to something you touched on a little bit earlier, where those LOCs are basically by region. Anything we can conclude from what you found there?
Dallas Wells: So there was enough difference here that frankly I'm not sure what to make of it because we saw big changes in pockets of the country and it makes you question again, what's the driver of this? Is it areas that have bigger impacts that are facing bigger issues? And so the hotspot for the virus in the US has been of course in New York and northeast area. We've got a whole bunch of lines of credit up there in New England, New Jersey, New York City area. Not a lot of change in their usage of lines of credit. And then in areas like the south central, which would include Texas, up 13% in their utilization of lines. So it is again, I think indicative of how the different banks are handling some of this. And I think in areas like New York, it is truly shut down, locked down while they deal with the health crisis at hand.
And I'm guessing some folks on the coast might be surprised at how much in parts of the midwest and in parts of Texas, things are much closer to business as usual. So yes, the schools are closed and you can't eat in a restaurant, it's carry out only. But there's still cars out in the street, there's still people functioning, most businesses are considered essential by some stretch of that definition. And so business goes on, but everybody's feeling the follow on economic effects. So I think that's why you're seeing businesses are still trying to function. They're drawing up those lines, just trying to function through this while in the hardest hit areas, they're like, nope, everybody shut down. Everybody stay home. Don't need to draw on the line because there's just not much happening right now. We'll deal with it later.
Jim Young: Yeah, that's an interesting point because the other area, again, we talked about it that we call the south central area, which is really a lot of that is Texas essentially, the other areas, central midwest. So yeah, where at the coastal areas, almost no uptick in usage at this point from what we're seeing. So what about industry? Is that one where there's stuff there that may be is more clearly defined?
Dallas Wells: So here's the maybe inside baseball, but any bankers will appreciate this because they deal with these same kinds of things. When we're talking about industry, we're talking about NAICS codes, N-A-I-C-S codes. So you're using sometimes some strange definitions for what an industry is. So we've got groupings of things that are, for example, like management of other businesses and enterprises. I don't know exactly what that means but we do have some lines of credit that that's their listed industry code and the usage is way up on that. So not sure what that means but there's others that are a little clearer and they're what you would expect. So accommodation and food services, utilization up 30%. By far, the biggest increase and exactly as you would expect. And those folks have been hit really hard. Same for healthcare and social services.
Those are up 14% so the areas you would expect that are hardest hit, healthcare, restaurants, hotels, those things where business has essentially gone to zero but they still have some costs going out the door. You're seeing those lines go up. Some of the ones that were surprising were the ones that actually went down and some of them make sense like warehousing was down, everything's being shipped. And the warehouses are very busy right now. Not business as usual by any stretch, but they're busy. But mining and gas extraction, some of those lines are down 3%. Just given the carnage in the price of oil over the last several weeks, surprising that those line balances would go down. And maybe it's just because prices are down and some of those operations are literally just laying down the wells. There's no activity there and maybe that's what we're capturing with that. So definitely some big variations within industries. Most of them are what you would expect but a few surprised us.
Jim Young: So brace yourself. Going to ask another possibly dumb non-banker question here, but is it possible on some of this, because we saw at the beginning of March when [inaudible] numbers that she puts out for us, big spike in just loans, period. And those sort of things. Is it possible that in some of those industries, what we're talking about rather than bumping up LOC usage or whatever, they just went ahead and got an actual big fixed rate loan instead earlier in the month? Just sort of say, hey, I got an idea. This is going to be bad. It's going to be bad for a few months. I'm going to go ahead and just get a big chunk of money coming my way.
Dallas Wells: No, you're exactly right. And I think that's part of the difference in changes by size. There's a lot of the small businesses, they went to their bank and were like, I need help. I need working capital right now. And the very largest middle market and corporate borrowers, they have revolvers in place that the banks are contractually obligated to extend to them versus the smallest ones probably had to go about it a different way. And that was some of the increase in volume that we saw there. So I think you're right.
Jim Young: Okay. All right. Well so let's talk about what, this will be a little tricky because we basically have spent most of this podcast saying, well, some of this was what we expected and some of it was what we didn't expect. So now I'm going to ask you, what do you expect going forward from this point on LOC?
Dallas Wells: Since I'm so good at prognosticating this.
Jim Young: You nailed it so far. So yeah. What do you expect probably at this point and what role will PPP have in any of this?
Dallas Wells: Yeah, so I think what we're seeing and what banks need to pay attention to is that there's going to be big changes in behavior but it's not this across the board kind of thing. It's there's opposite ends of the spectrum that sometimes are balancing each other out but that doesn't mean that nothing's happening inside the portfolio. So don't be fooled by the total balances and total usage and even in the top level risk metrics within your portfolio. Those could be hiding some real issues lurking in there. So the PPP, it sounds like as we record here, there's probably going to be new rounds of that that'll have to be approved through Congress that the first round looks like it's going quickly and already the treasury and others are saying it looks like we're going to start right now going back for the next round of that.
So some of it will depend on what sort of other programs come along here and where are those aimed and how are they used. But I think the longterm answer is that there's economic consequences here that can't all be covered by a government bailout. There will be increased usage of lines as people just need to access that debt to survive. And it will happen in pockets pretty dramatically so the averages will tick up but it'll be because of big changes in certain industries and certain borrower types and even in certain parts of the country that are just different and they're seeing different consequences of this. So, I think that's the real answer is that probably increased usage overall but that's just a fraction of the story. It's really about understanding your own portfolio and then figuring out how to see those things as they happen and actually do something about it.
Jim Young: Yeah. And I'm curious about that because when banks come and ask us some questions about this sort of thing, is there any other, I guess for lack of a better word, advice that we've been giving on that? And I guess I'm also thinking in terms of customers coming to them and saying, "Hey, can we bump up my LOC limits, can I get some more on this line?" And how to handle that situation when, again, you're trying to be helpful and trying to serve loyal customers, but also trying to balance that with risk on your portfolio.
Dallas Wells: I think your question started to touch on the trickiness of it there. So I'm going to answer this two ways just so that we can see both ends of it. From a cold, sterile mathematical look at it, what you should be doing from a risk management perspective only would be identifying those areas where there's trouble and most loan documents have language in there around adverse financial situations. And basically you don't have to extend those draws on that line. You have the ability to say no to them if there's been a material change in that borrower's financial health. Well that probably qualifies just about everybody for that exemption. Banks also, as they were growing a lot over the last couple years, we had a number of banks that were doing a whole bunch of uncommitted lines, meaning it's a line of credit, it's in place, but we're not really on the hook for it and we don't even have to hold capital for it.
So we had to do a whole bunch of adjustments to risk adjusted profitability calculations on those to make sure we get the capital piece right. What that means though is that you're going to have a lot of borrowers coming to you that you're not contractually obligated to extend debt to. And so the mathematical credit department view of this is probably going to be, the answer is no, you don't get that money. Now on the other side, you have the reality of how this whole thing is being perceived. And again, you can look to the PPP program and some of the reactions to that to see how dangerous of a situation this is for banks. And what I mean by dangerous is telling people no right now when they feel like you have the ability to help them is a huge reputational risk. So day one of the PPP applications, lots of banks, the one that saw the most attention from it because they're the biggest was Bank of America, but lots of banks said, basically I'll summarize it, but this is a complicated program.
We have to do some know your customers criteria here to be able to do these things. So the only realistic way that we have of handling the volume and being able to get this up and going quickly is we will do these loans for customers that we have existing loan relationships with already. So if you already borrow money at Bank of America or lots of other banks did it this way, we will process yours quickly. For everybody else, the answer is not right now. The backlash against those banks was surprising in its nastiness. And we feel for the banks because we know the logistic reasons of why they were doing it that way. It was so that they could move quickly. It was so that they could serve the customers that were already doing business with them. But that means that there was people who, hey, I've had a deposit account at this bank for 20 years and when I finally went to them because there was this thing where I needed help, they told me to buzz off.
So that, in a nutshell, I think it would be even worse if you've got an uncommitted line or even worse than that, a committed line that you said, well, the world has changed. So no, you can't draw down on that when you actually need it. It becomes the classic banks will sell you an umbrella except if it's raining. And the reputation risk versus the credit risk is the balance that banks are going to have to strike going forward. So how should they handle those? All I would say is you better be intentional. You better have a strategy that's consistent, that's being well-communicated to your RMs that are actually talking to these customers so that you have the right approach because otherwise you're going to have pockets of your bank doing different things, especially since most of them are working from home right now.
You're going to have some people telling your customers no, we're not extending you that credit and you're going to have others that are, yeah, we're supposed to be helping you right now. You can have whatever you want. Neither of those is necessarily the wrong answer. You just better be intentional about what you want that answer to be and make sure your bankers are aware of that.
Jim Young: Yeah, it's interesting because I've seen this a lot and of course social media is not always the best way to judge the true feelings of the public but there's been a lot of callbacks to 2008 with oh, last time the American public bailed you guys out and now it's your turn to help us out. And I mean that is a very easy gotcha sort of thing to say. But as you pointed out, we come at this from the perspective of banks are our clients and it's very understandable. And what you walked me through with what Bank of America said, I'm like yep. Makes sense. But I think that's also... You've talked about being intentional and this gets into my area, which is the marketing and public relations.
I think you need to be as transparent and intentional with what you say publicly. And maybe that step is not the, hey, these are the only people that matter to us, which is not what they said, but be very clear on we're getting overwhelmed here. This is coming at us and we are getting these out as fast as possible. If you want to understand why it's taking you a while, well this is the order that we're doing it in. And again, you're always going to get backlash on this, but at least if you can be, I think the way, this is always the way I think about this stuff when it comes to public relations, if you can be as honest and as open as possible, transparent as possible in why we're doing things, people tend to understand if you give them a little bit of, hey, I would love to get this to you sooner but here is why I can't. That gets you a little bit more goodwill with the whole thing. If you try to spin it in a certain way, then you'll usually get caught up in it.
Dallas Wells: Yeah. That's not going to work right now.
Jim Young: Yeah, exactly. Alrighty. Well I think that'll do it for this week's podcast and I'm sure when the next one comes around we'll have another thorny issue to deal with and numbers that aren't quite as clear as we would like them to be and answers that aren't quite as clear cut as we would like them to be, but by God, that's not going to stop us from continuing to put out these podcasts for you.
Dallas Wells: The show must go on, right?
Jim Young: Exactly. Exactly. All right. Well as we noted in the beginning, this episode topic comes from the questions we're getting from clients about what we're seeing in our Precision Lender database. If you've got a question you'd like us to research, just a topic you want us to tackle, please send me an email. Again, it's initial firstname.lastname@example.org and that'll be in the show notes as well. That'll do it for this week's show now. Thanks again for listening. Now for a few friendly reminders. If you want to listen to more podcasts or check out more of our content, visit our resource page at precisionlender.com or you can head over to our home page to learn more about the company behind the content. If you like what you've been hearing, make sure to subscribe to the feed in iTunes, Google Play, or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young with Dallas Wells, and you've been listening to The Purposeful Banker.
About the Author
Follow on Linkedin
More Content by Jim Young