The Truth About Banks and Lending

I convinced a banker friend to submit to an anonymous interview with me.  I agreed to keep the dialogue in the interview completely confidential and anonymous.  For this reason, he was able to admit some pretty shocking things to me. Things that bankers just can’t talk about or admit, without the risk of losing their jobs or worse, getting cut off from the precious TARP money from the government.

Before you read the interview, I am encouraging all of you to contribute your comments below, at the end of this interview.  I expect that most of you won’t be surprised by any of the answers to the questions below, in fact, most of you will think to yourselves, ‘Doesn’t everyone already know this?’

However, the majority of people out there really don’t know what’s happening in banks and lending.  A program that was intended to pull banks, and thus our economy out of this crisis, has only invited more abuse and greed in the banking world, and further delayed inevitable bankruptcy.

• How long have you been with this particular bank?

15 years

• Is this a community bank, a regional bank, or national?

It is a community bank that focuses on commercial loans.

• What is your title at the bank?

I was a commercial loan officer for 10 years. I am now Vice President of the commercial division of our bank.

• Tell me a bit more about how lending has changed over the last few years at your bank? For example, number of loans your bank was making then, versus now, the requirements then versus now, etc.

In 2006 we were making 125 commercial loans per year.  In 2009, we made 36 commercial loans.  In 2006, we lent based on appraised value, up to 85% of appraised value.  We also did not require borrowers to have a depository relationship with us in 2006.  Now, we lend primarily based on the DSCR, and up to 75% of value or the purchase price.  However, our average loan to value is actually only 70%.  We also require borrowers to establish a depository relationship with us. Typically 20% of the loan amount.

• So let me clarify what you’re saying. If a borrower comes to you with a commercial building that he or she can buy for fifty cents on the dollar, you are still requiring a 30% down payment based on the purchase price plus an additional cash deposit of 20%?

Correct. Even if the building is worth much more than our customer is buying it for, we are still only lending 70% of the actual purchase price.

• O.k., let’s use an example then, just to illustrate the numbers here. Let’s say I’m able to buy a building that’s worth $2 MM for $1 MM.  I’m coming to your bank for a loan of $1 MM to buy this building.  In this case, I’ll need to bring in a $300,000 down payment in cash as well as a $140,000 cash deposit.  This is a total of $440,000 in cash that I need to put up for a loan of $700,000?

That is correct.

• Wow. Unbelievable.

Yes, that is the reality I’m afraid.  If we give you a loan at all.

• So based on what you told me about only issuing 36 commercial loans total last year, you aren’t really lending right now are you?

Frankly, no.

• Do you think your bank will stay afloat and outlast this crisis?

Yes, I think we will.  The only reason we’re still operating is due to the conservative stance our President took at the end of 2006.  After 2006 we began to curtail our lending a bit because our President could see the bubble about to burst.  During that time, there was a lot of pressure on us to compete with other banks. The lending environment was very competitive, and frankly, it was out of control.  Some of our competitors were making 48 hour closings on commercial loans. In order to compete for the business, we were being pushed to do the same. Looking back, this was ridiculous, but at the time, it was just, well, business as usual.  Unfortunately, our competitors that were putting pressure on us at that time to keep up, well, they’re all out of business.

• That’s sad.  I guess the writing was on the wall though. Your bank’s President sounds like a smart guy.

Yes. He was, and is. Too bad our Board of Directors forced him to resign shortly after the bubble burst.

• What has happened to your bank since the bubble burst?

Well, we bought a larger, regional bank that was going out of business.  The problem is, they only had to disclose their “bad loans” at the time of the purchase. They did not have to disclose those loans that they knew were about to become “bad loans.”  So, shortly after the purchase was complete, we found out about a lot of problematic, or soon to be bad loans in their portfolio.  And, just as we feared, many of these “problematic” loans started to go into default, soon after the purchase.

• So what now?

Unfortunately, we must set aside a large sum of capital in reserves to cover these bad loans, 80% of the loan amount, for each loan that is in default.  This has eaten up all of our capital, which we could be using to make new commercial loans.  This is the primary reason we are unable to lend right now.  We are not lending because we are short on capital.

• But what about the TARP money from the government? Didn’t your bank receive any of this?

Yes, we’ve received over $50 MM.

• Wasn’t this government money meant to keep banks like yours lending? $50 MM is a lot of money to make loans with.

Yes, technically it was meant for that purpose. But I think most banks like ours are using their TARP money to cover bad loans on their books.

• Ugh. That’s the ugly truth.  So, that $50 MM dollars, that was lent to you by the U.S. government to keep lending, and indirectly to keep the wheels of our economy turning. You are using that to cover your bad loans and not to make new ones? And there’s no accountability, no regulations on this?

Correct to the first question. And, no, not really, to the second question. There are no regulations. It’s a pretty screwed up system. I can say that because I’m on the inside. I know first hand how it ticks. And this is exactly why I’m not supposed to say that we are not lending. If anyone caught wind that we are “not lending,” we’d be in a lot of trouble and those government loans would be called in immediately, if we weren’t shut down altogether.

• So what about your commercial borrowers? The ones that have a long-term relationship with your bank? Are you renewing their loans?

No. Unfortunately these are the customers that are getting hurt the worst in this whole thing.

• Why?

Well most of them have just completed their Phase I financing and are coming back to us for perm.  Some of these customers have been banking with us for over 20 years. We know their first names and we’ve seen their kids grow up etc.  When they come to us for this perm financing or after a 3 to 5 year call to refinance, we have to tell them to pay us off and go to another bank.

• What happens to them?

Most of them are so strong that we are hoping that they will be able to obtain a loan elsewhere.

• This seems backwards. Aren’t you trying to obtain more deposits? These customers are taking their deposits and walking.

Well, right now we need to raise capital through stock issue.  Investors won’t look at our stock unless no more than 20% of our portfolio is secured by commercial real estate.  This means we have to get this ratio down to attract investors to purchase our stock.  This is why we are not issuing new commercial loans. I think a lot of banks are in this same position.

This concludes the end of the interview with a banker. This story is not the same for all banks.  Some banks are stronger than others and have sufficient capital to continue making news loans.  However, the truth is that many banks are actually turning away long-term customers that have never made a late payment on their commercial loans. Customers with which they have built long-term relationships for 20 years or more.  These are the people who are truly getting hurt in all of this.

The more grim outcome of banks not lending, even though they have been lent millions by the U.S. government in order to keep doing so, is that the mere action of lending to businesses is what fuels our economy. This action creates jobs, and inventories of stuff that people buy, or services that people buy and sell, and profits which allow loans to get paid back, and then the cycle repeats itself over, and over, and over again.  Lending is the impetus behind this precious cycle.

Please leave your comments, good or bad, negative or positive. I’d love to hear from you on this controversial topic. Or, share your own story or a story of your clients. Please share.

Posted by Corey Curwick on March 21, 2010