Wednesday, April 16, 2014

Are Banks Over-Reaching For Loan Growth?

Banks That Grow Too Fast Hurt The System

I’ve been keeping a close eye on JPMorgan Chase lately because they appear to be in bunker mode, meaning they are storing up tons of cash (more on that latter) and proving to be tight-fisted lenders, especially in Commercial and Industrial (C&I) lending. With a loan to deposit ratio of 56% and sharp words of caution about competitor lending practices, I am beginning to think JPM sees the End Times near.
If JPM is worried, should bankers and bank investors worry too?
In my book I coined the term, “10X Risk”, to describe bone-headed mistakes that kill banks or destroy massive shareholder value. My in-depth research of bank failures reveals that the most common 10X Risk occurs when over-confident management and directors reach for loan growth.
Banks that grow fast are either smarter than the average banker (they always think that), built a new mousetrap (maybe, but it takes about two weeks for competitors to replicate), or just down-right daredevils (most likely).
When the industry grows much faster than the growth rate of GDP (1.9% in 2013 and 2.9% over the past 30 years), history shows there is an eventual reversion to the mean.Sometimes, as we saw in the mid-1980s and more recently starting in 2008, the reversion can be violent, leading to hundreds of bank failures.
C&I is a bread-and-butter loan category for commercial banks. The CEOs of the vast majority of banks grew up doing C&I lending. Since C&I is so crucial to U.S. bank profits, I took special notice of this comment made on the April 11 Analyst Call by Marianne Lake, JPM's Chief Finance Officer:
"We are seeing the ongoing aggressive investing environment on both credit terms and pricing, we will do every rational and sensible deal we can do but we are not going to chase growth at the expense of discipline.”
For those readers unaccustomed to banker talk, “aggressive” is code-word for "dumb." Lake is saying that there are some bankers so desperate to improve earnings (and their stock prices…and their bonuses?) that they are making loans they shouldn't.
Is she right?
I just returned from a conference where I spoke about the future of U.S. banking with bank risk executives from four states. In my conversations with these bankers I heard three messages consistent with what I am hearing from bankers across the country:
  1. C&I loan growth is one of their bank’s top goals for 2014.
  2. C&I loan demand is sluggish.
  3. Pricing on C&I loans is getting cut to the bone and loan structures are becoming more liberal.
In the lemming-like world of U.S. banking, it’s safe to say that C&I lending is the “next hot thing” for bankers. The good news is that there are plenty of banks out there with long-tenured, seasoned bankers at the helm who have seen this movie before and they don’t plan to buy a ticket to see it again.
On the other hand, if Marianne Lake is right, apparently there are some bankers and directors unfamiliar with this horror show.
I am curious: Are banks starting to take short-cuts again? If so, which ones are you worried about?
In the meantime, I am digging into C&I loan growth data across the industry. Stay tuned.

Written by Richard J. Parsons
Broke: America's Banking System

Richard J. Parsons is an Author, Speaker, Educator and Business Advisor in the Financial Services industry.  After a 31 year career at Bank of America, Rick founded the RJ Parsons Group in 2012. Rick published his first book in 2013, "Broke: America's Banking System - Common Sense Ideas to Fix Banking in America." He can be reached through his website or via social media including @RJParsonsGroup and LinkedIn.


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