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More Interest in Business Loans

By Mark Green

Kentucky commercial lending activity increased in 2011, reflecting slowly but steadily improving business fundamentals working out of the lingering effects of the 2008 financial crisis and resulting recession. Commonwealth business lending likely tracked the 10 percent increase nationwide last year, and expectations are for an even better 2012.

Banks and experts who monitor finance generally believe business lending will expand further in Kentucky this year, despite tougher bank lending standards and a strict regulatory environment.

The optimistic expectations change, they said, if an external economic problem such as European sovereign debt defaults, creating a follow-on financial crisis, or the price of oil generating record gasoline prices that drain U.S. consumer’s confidence levels.

“I think business is really good,” said Chuck Denny, Kentucky president of PNC Bank, which has the most branches and largest share of deposits in the state. “As I look at our business line in commercial lending and in business lending, even in commercial construction, all of our business areas are up. They were up in ’11, and we’ve started out really strong in ‘12.”

PNC saw “pretty steady” business through last year, including “some real strong months the last half of the year,” Denny said. PNC has 135 Kentucky branches in most of the state, including Louisville, Northern Kentucky, Lexington, Bowling Green, Owensboro and up and down I-65 and I-75.

“About the economy and markets in Kentucky,” he said, “I see strength. I see optimism. I see investment. I see modest expansion.”

Fifth Third Bank is second largest in the state by deposit market share.

“We are up double digits in our commercial and industrial lending,” said Mike Ash, the bank’s city president for Lexington and senior vice president for commercial lending.

Most of that borrowing is being done by larger companies with strong financial positions, said Tom Partridge, Fifth Third’s Kentucky president/ CEO. He described a distinct difference between recent business and borrowing activity by large companies with at least $50 million in annual sales compared to midmarket and smaller companies with sales of $20 million and less.

“For large companies, they are clearly taking advantage of the market to make investments, to do things for their business, to make investments,” he said. “They have a lot of liquidity and a lot of balance sheet strength.”

Mid-market and smaller companies are not borrowing as much. They remain far more cautious to take on risk, to borrow and spend on a new project, and to hire employees, Partridge said.
“They continue to hoard cash and to pay down debt,” Partridge said.

Fifth Third “has a lot of money available to lend,” Ash said. While the bank definitely sees more lending opportunities among larger companies, there is not a focus on them to the exclusion of others.

“We’re talking to everybody,” Ash said.

“Bank lending has rebounded. It has taken awhile,” said Don Mullineaux, a University of Kentucky professor who holds the duPont Endowed Chair in Banking and Financial Services in the Gatton College of Business and Economics. “The area that has rebounded has been business lending.”

National statistics indicated 10 percent growth in business lending during the past four quarters, Mullineaux said. (State-level statistics on lending are not available.) Meanwhile, construction loans have been down for 14 consecutive quarters and aren’t expected to rebuild their numbers soon, he said.

Banks aren’t critics of regulatory environment
Since the financial crisis struck in fall 2008, multiple factors have combined to keep lending and economic growth at low levels, even after the official end of recession in late 2009.

“Banks had well above historic levels of losses in a typical recession,” Mullineaux said.

Bankers raised lending standards, which is a natural reaction. Regulators at the Federal Reserve, the U.S. Comptroller of the Currency and the FDIC also increased banks’ capital reserve requirements because of the loan losses – many a result of subprime mortgages and loans for construction projects linked to an overheated residential and commercial real estate market. Although Kentucky’s economy and banks did not participate in the excesses as significantly as elsewhere, the impact was significant.

The bar for loan-qualification standards moved higher at the same time many potential borrowers’ credit ratings were falling drastically because they not only had less cash on hand, but the value of their equity and other collateral had declined.

One frustrating result: The recession’s official end was mid-2009, but a leaner-operating U.S. economy has had an extended period of high productivity but low growth. Large, established well-managed corporations have amassed profits and are well-qualified for loans but have neither needed nor wanted to borrow because broader economic activity and near-term prospects did not warrant it. Medium and smaller companies and small businesses that have wanted and needed to borrow lacked the balance sheets to qualify.

There has been much speculation that banking regulators and new laws, especially the federal Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, have overcompensated and curtailed lending, acting as a brake on economic activity just when growth was needed most. However, Kentucky bankers are not big critics of the regulators, and Mullineaux said Dodd-Frank has no direct effect on lending.

“I’m hearing a lot about DoddFrank,” Mullineaux said. “But there is virtually no tie to bank lending.”

In fact, only about a fourth of the rules to implement Dodd-Frank goals have been written and approved, Mullineaux said.

“The areas that we are trying to regulate are incredibly complex,” he said. “It is extraordinarily difficult for regulators to formulate the rules because of how complex the issues are.”

Mullineaux said it is difficult to judge in real time whether banking regulators are overzealous. He did note that the recent period has been an ironic one in which Federal Reserve Chairman Ben Bernanke is publicly encouraging increased bank lending, but front-line regulators “are more strict in tone than those at the top.”

Partridge said criticism of banking regulators is at least partly unfair. Their tougher line is “a natural outcome of the downturn.” Meanwhile, regulators take hits for not being tough enough before the economic crisis. He credits the recent difficult lending environment primarily to natural motivations and processes.

It is unrealistic to expect regulators to tighten the screws when the economy is good or to be lenient when it is bad.

“The fact is that the trough was so big this time, it’s taking longer for underwriting standards to move in the other direction,” Partridge said.

According to the most recent statistics at fdic.gov, the rate of noncurrent commercial and industrial loans for all U.S. banks was 1.47 percent for the third quarter of 2011. That is a 46 percent drop from a year earlier.

At Mount Sterling-based Traditional Bank, which operates in five central Kentucky counties and holds the No. 5 position in the Lexington market, President Bill Alverson said new regulatory requirements have been a challenge for banks and Traditional has had to add staff especially to keep up and comply with them.

Economic and lending activity has been “moving slowly,” Alverson said, but there has been a noticeable increase in inquiries by potential borrowers regarding commercial property purchases. That has not translated into sales, but inevitably such activity does correlate into deals, he said.