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There are certainly some very positive findings in the recent National Association for Business Economics (NABE) survey, and this is welcome news. The respondents indicated that their economic outlook has improved, profits have increased, and job creation has increased.
However, this finding is troubling:
Nearly half of those surveyed said credit conditions were hurting their operations, compared with 35 percent in January.
Here’s my question: Why are MORE companies saying business credit conditions are hurting operations than in January while at the same time businesses are saying economic conditions are improving?
I believe the short answer is that more businesses are in the position where they NEED business credit as the economy recovers (efficiency is at an all time high– they need to hire; they are getting more orders, etc.). Unfortunately, as our friends at Greenwich Associates have recently stated, banks are notorious for resuming normalized levels of lending on the back side of a recession. Ftrans’ research indicates a 12 to 18 month horizon before business lending may normalize.
Businesses that have survived phase I of the economic downturn and credit crisis now need to get creative to finance growth in an upturn. Welcome to the Catch 22 of the continuing credit crisis.
In consumer lending, Lending Tree made a name for itself with positioning along the lines of, “When banks compete, you win.” Thanks to social lending sites such as Prosper and Lending Club, today’s positioning is more like ”When your neighbors compete, you win.” This is particularly true for micro and small business borrowers that are traditionally underserved by banks because they fall outside of the bank’s “credit box.” Read this recent article in Forbes for more insight. Our experience in the market tells us:
- Lending and investment options for small businesses continue to be limited
- Small businesses need to be creative and consider all options to improve their balance sheet, cash on hand, etc.
- Even businesses that are able to identify interested investors need to have processes in place that provide insight into customer risk, etc.
- Outside investment is only part of the solution
Connecting the dots: Growing losses in community bank commercial real estate portfolios could jeopardize our overall recovery by stymieing lending to small business. Community banks account for nearly 50 percent of loans to small businesses. A recently published report from the Congressional Oversight Panel created to oversee the Treasury‟s $ 700 billion TARP bailout program highlights a serious threat to the economy from the weakening financial fundamentals in the commercial real estate sector. Similar to the recent collapse of the residential market, Elizabeth Warren, chair of the Panel stated “…there‟s been an enormous bubble in commercial real estate, and it has to come down.”
The panel warned that of the approximately 8,100 U.S. banks, nearly 36% of them are small regional and community banks with problematic exposure to commercial real estate. Problematic in the sense that commercial real estate loans represent at least 300% of total capital or their construction and land loans exceeds 100% of total capital.
The Congressional Oversight Panel also warned that almost 3,000 small banks could be forced to curtail their lending because of growing losses in their commercial real estate portfolios. This reduction in lending can severely jeopardize the economic recovery as these banks account for nearly 50 percent of loans to small businesses.
Edgar Ortiz is President and CEO of Strategic Analytic Solutions, an Atlanta- based management consulting firm that provides Strategic Planning, Predictive Analytics and Credit Risk Management Advisory services to small and midsize businesses. He can be reached at ortiz@strategicanalyticsolutions.com.
A recently published report from the Congressional Oversight Panel created to oversee the Treasury’s $ 700 billion TARP bailout program highlights a serious threat to the economy from the weakening financial fundamentals in the commercial real estate sector. Similar to the recent collapse of the residential market, Elizabeth Warren, chair of the Panel stated “…there’s been an enormous bubble in commercial real estate, and it has to come down.”
The panel also warned that of the approximately 8,100 U.S. banks; nearly 36% of them are small regional and community banks with problematic exposure to commercial real estate. Problematic in the sense that commercial real estate loans represent at least 300% of total capital or their construction and land loans exceeds 100% of total capital.
The Congressional Oversight Panel also warned that almost 3,000 small banks could be forced to curtail their lending because of growing losses in their commercial real estate portfolios. This reduction in lending can severely jeopardize the economic recovery as these banks account for nearly 50 percent of loans to small businesses.
Jobs are the key to move the economy out of its current slump. Most jobs are created by small businesses. It is fundamental, therefore, that we ensure the financial stability of our small regional and community banks as they are the major source of financing to small businesses who ultimately create over 70% of new jobs.
There is a growing concern that a wave of loan defaults in the commercial real estate sector will hit the economy contributing to the insolvency of hundreds of small regional and community banks curtailing access to credit to the local business community and prolong the economic recovery.
Although profitable during the building boom days of the last decade, this disproportionately high allocation of capital into commercial real estate, poses a serious threat to the survival of small and regional community banks, as they continue to experience:
- Growing delinquencies
- High number of vacancies in strip malls, office buildings, hotels, apartments and shopping centers.
- Reductions in property values as nearly half of all outstanding commercial loans today are “underwater” with borrowers owing more than the property is worth today. In some areas, property values have lost more than 40 percent since 2007.
During the 2000 to 2008 period, many small and regional banks leveraged trust-preferred securities, a popular financial instrument to raise investment capital. Their wide acceptance and popularity helped fuel the booming commercial real estate market and more than 1,500 small community banks issued over $50 billion of trust-preferred securities over this period.
Not to miss the opportunity, Wall Street brokerage firms got into the action and began marketing them as profitable, but low risk investments. The process was straightforward as they:
- Bought trust-preferred securities from individual banks.
- Packaged them into ‘pools’ of collaterized-debt obligations (CDOs), and
- Sold them back investors.
Banks liked them because of their hybrid characteristic of debt and equity. If issued by a bank holding company (BHC), up to 25% of a bank’s Tier 1 capital could originate from funds raised through trust-preferred security offerings in the market.
When the economy went into recession and the commercial real estate market faltered with decreasing property values and growing loan losses, a growing number of small banks, issuers of these securities could no longer meet their financial obligations. In the first half of 2009, 119 issuers of these securities had postponed paying dividends and 25 had defaulted on them.
Holding these securities continues to be problematic for the large number of small banks that bought them, because trust-preferred securities were subordinated to all of the issuing BHC’s other debt. Any losses in the value of these securities reduces their capital ratios and curtails their lending capacity to small businesses, the engine of growth of the economy.
Although viewed as an attractive option for a BHC to bolster its regulatory capital during profitable periods, these securities turned out to be problematic when financial conditions deteriorated causing them to write down the securities to their market value, absorbing huge losses, weakening their capital cushions and lowering their capital ratios.
Small regional and community banks now face one of the most challenging market conditions since the 1980s and may bear the brunt of losses in the commercial real estate sector. As noted by Ed Mierzwinski, of the U.S. Public Interest Research Group, in recapping observations from the Congressional Oversight Panel, this wave of defaults “may be the next flashpoint of the financial crisis.”
Edgar Ortiz is President and CEO of Strategic Analytic Solutions, an Atlanta- based management consulting firm that provides Strategic Planning, Predictive Analytics and Credit Risk Management Advisory services to small and midsize businesses. He can be reached at ortiz@strategicanalyticsolutions.com.
