Ron Wysaske: Lending by banks will slowly rebound
Sunday, January 23, 2011
• Underwriting standards will remain strict, with high cash flows required of businesses seeking loans.
• Companies that do get loans will be asked for additional payment guarantees, and face shorter amortization schedules.
• Banks will eventually increase lending, but it will take time.
Back to 2011 Economic Forecast Breakfast home page.
Bankers and their customers will not forget the past few years.
In 2009 and 2010, we saw the demise of some 300 banks across the U.S., including 21 banks in the Pacific Northwest. Another 200 banks could fail nationwide in the next few years.
It would seem, though, we are through the worst of it. Surviving banks will have stronger capital levels and better risk management. Bankers should also, however, have a palpable fear of the kinds of risk that will eventually take down more than 500 banks. This will affect the decisions made by bankers and bank regulators for years to come.
Generally, we would expect credit to remain tight, or difficult to obtain, particularly for real estate-based borrowing.
However, what we noted last year is still true: A business that generates cash and doesn’t rely upon the real estate markets is a desirable customer for all business banks. Liquidity, capital, and revenue are still the medicine for what ails most companies, and individuals, in this economy — and that especially includes banks.
Here in Clark County and the Portland region, the public and many banks have suffered from the risks inherent in real estate-based financing. In response to the economic downturn, commercial real estate loan underwriting has tightened, and will continue to be tight compared to the standards used prior to 2009.
Loan to value limits are lower (tighter) and less relevant, because determining real market value is difficult, given the lack of comparable property sales. Debt service coverage ratios and required cash flows are higher (also tighter) and much more relevant, since periodic cash flows, such as rents, are readily verifiable.
Banks want to make sure that the enterprise, or property, can generate cash sufficient to make the debt service payments without having to sell the underlying real estate collateral.
In today’s uncertain economic environment, as in the past two years, cash-flow requirements are higher than they have been historically, because it is hard forecast how they will fluctuate. For example, in 2008, periodic cash flow requirements might have been 1.1 to 1.2 times the debt service (principal plus interest payments). For 2010 and likely 2011, the required cash flows will be closer to 1.3 to 1.4 times debt service.
Banks are typically requiring payment guarantees from business partners, spouses, or other debtors.
Pay-downs or amortization requirements are more stringent, typically using 25 year amortization schedules, with 10-year payoffs. As recently as 2008, 30-year amortizations would suffice.
Vacancy rates have increased and, even with reduced lease rates and terms, property owners find it hard to locate and retain tenants who can pay. Thus, with reduced net operating incomes and higher capitalization rates, virtually all property valuations are lower, as is the associated return on investment to the current borrower or property owner.
All of these “tighter” terms have the effect of requiring a greater cash-flow cushion. More cash flow equals less risk, and banks don’t have much appetite for increased risk. This is the story as we enter 2011.
More pain is likely to occur. Relief will take time. We can and will pull out of this eventually, but it will be a slow climb out.