February 13, 2008 Wednesday
Rate Review: Perspectives From Commercial Lenders
BYLINE: Matthias Rieker
SECTION: NATIONAL/GLOBAL; Pg. 1 Vol. 173 No. 30
For commercial lenders, the Federal Reserve Board's flurry of interest rate cuts last month was welcome news insofar as the cuts restored the possibility of a more normal rate curve and, by extension, better profit margins.
What it has not done yet, according to lenders at some of the nation's biggest banking companies, is restore commercial borrowers' confidence enough to increase their capital spending plans.
"I don't think" commercial borrowers looked at the rate cuts "as 'Wow, our cost of capital is going down, and now our break-even on marginal products is more positive, and we are going ahead and invest,' " said Ray Whitacre, the head of middle-market commercial lending at Harris Bankcorp Inc., Bank of Montreal looked at it as beneficial but are not necessarily going to change the way they are doing business over the next three months."
Economists have long said it takes months for the central bank's rate cuts to show up in economic gains. Still, bankers say the outlook for commercial borrowing, particularly in the middle market, is very sensitive to economic expectations, and it is one business that some had hoped would provide a bulwark as consumer credit worsened.
That hope is not quite panning out - in general bankers say their commercial lending expectations have not improved as a result of the Fed's 125 basis points of cuts that took the federal funds rate down to 3%.
"We are expecting more modest growth than we would have expected, say, 90 days ago," Carlos Evans, Wachovia Corp.'s head of wholesale banking, said in an interview last week.
At the same time, bankers said they did not see evidence of an actual contraction or the kind of pullback that would indicate an extended economic downturn.
"If you believe that we are about to enter in a recession, it looks very different from anything I have ever seen in my 35 years," Mr. Evans said. "Generally speaking, the tone would be much more pessimistic than it is right now. I think our customers are concerned, but they are OK."
Mr. Whitacre said: "I don't think we are changing our viewpoint. We still believe the economy will rebound, certainly in the second half."
That is not to say borrowers are unconcerned about the economy's direction. Mr. Whitacre said he was with a group of clients when the Fed announced its 75-basis-point rate cut Jan. 22. The borrowers were surprised, he said. "They hadn't seen ... [the economy] as bad as you read about. Their businesses were still performing OK, so when they saw it, they said, 'Wow, I wonder if it isn't worse than we thought.' "
In recent weeks downcast predictions have mushroomed.
"The probability of U.S. recession has now risen to around 70%, from 50% at the turn of the year," Scott Anderson, a senior economist at Wells Fargo & Co., wrote in an e-mail to clients.
Richard J. DeKaser, the chief economist at National City Corp., was more optimistic. When asked Tuesday whether he expects a recession, he said, "I don't," though he quickly added, "I feel like a very lonely forecaster."
He also noted that Nat City's January survey of business owners showed that their confidence has fallen to the lowest level since the Cleveland company introduced the monthly survey in 2005. But again he said that a majority of business owners have a positive view of the economy.
Samuel Todd Maclin, the head of commercial banking at JPMorgan Chase & Co., said the rate cuts will help business borrowers get through this cycle.
"Bankers are encouraged that rates are being cut, because at a minimum it's going to help companies avoid worse circumstances," Mr. Maclin said. "I don't think that we know the extent to which there will be a market downturn, but what we do know is if the Fed reduces interest rates, it benefits middle-market companies. These reductions are helping their cost structure."
However, companies still face a number of uncertainties in the current environment, he said. "If they have revenue problems, if there are backlogs, if inventories are rising, is it enough to maintain profitability, or profitability at the same levels? And for the more leveraged companies, is it enough to keep them alive and well?"
Of course, regional differences also play into the reaction to the Fed's cuts. Mike Slocum, the head of commercial banking at Capital One Financial Corp., said in an interview last week that the oil-producing economies of Texas and Louisiana feel little need for stimulus. When it comes to whether the rate cuts "really change anything there ... my answer would be, not much."
In New Jersey and New York, business owners also seem to have remained largely indifferent, he said.
However, Christopher G. Marshall, the chief financial officer of Fifth Third Bancorp, sounded relieved.
The 75-basis-point cut "was what was called for," he said in an interview Jan. 22. "We do hope ... that it does begin to disperse some economic activity within our footprint."
Fifth Third's commercial loans, excluding commercial real estate and construction loans, rose 19% in the fourth quarter from a year earlier, to $24.8 billion. JPMorgan Chase's fourth-quarter income from middle-market commercial banking rose 13%, to $288 million. And Mr. Evans' loan book at Wachovia grew 10%, to $67.3 billion. Bank of Montreal does not break out Harris' commercial loan growth. Similarly, Capital One does not break out its commercial loan growth, though Mr. Slocum said he expects loan growth in the range of 5% to 10% this year.
The Fed's most recent loan officer opinion survey showed bankers have tightened credit standards for commercial and industrial loans of all sizes. "Large domestic banks reported that demand for C&I loans from large and middle-market firms was about unchanged" in the fourth quarter from the third, the survey said, though 35% of small banks reported some weakening.
A commercial loan portfolio manager at one of the largest banking companies, who asked not to be named, said that small-business owners are more likely than middle-market and large companies to be concerned, because they could feel a slowdown in consumer spending more quickly.
As a result, small-business borrowers might pay back their loans instead of taking out new ones, the banker said.
But despite the tighter credit standards, bankers say that competition for middle-market commercial loans remains stiff.
JPMorgan Chase's Mr. Maclin even said he fears that some banks, in their effort to retain middle-market borrowers, might get overly aggressive and undermine underwriting standards, causing the same kind of credit deterioration currently in evidence in commercial real estate.
Wachovia's Mr. Evans said bankers are "still being very aggressive." Nevertheless, "we are not seeing recklessness," he said. "We are just seeing good, solid competition for business, which I think is healthy. All banks are trying to push for better terms and a little bit more price."
