Banks Need Experience to Prevent Bad Loans (Gwen Moritz Editor’s Note)

News flash: Problem loans have doubled in the past two years, return on assets is below 1 percent nationally, profits have been slashed and federal regulators are worried that banks have loosened their credit standards too much.

Not to sound smug, but I had already figured all that out just from anecdotal evidence in the news pages.

Five weeks ago, Charles F. Luter at Peoples Bank in Paragould told Arkansas Business that aggressive lending had helped his bank’s assets grow something like 13 percent since March. As a result, “we’re going to have to reserve more than usual,” he confessed.

Two weeks ago, we reported that 11 banks were under regulatory letter from the State Bank Department, up from two last year and six in late May. A third of state-chartered banks reported delinquent loans and repossessed assets greater than 1 percent of assets, and 12 had delinquencies above 2 percent of assets.

In our last issue, we reported in detail on six banks, large and small, that gave sizable, sometimes repeated, loans to former Razorback and NFL football player-turned-sports agent Elbert Crawford III. Incredibly, and inexplicably, four of those banks — River Valley Bank in Russellville, the Union Bank of Bryant, Merchants & Planters Bank in Sparkman and National Bank of Arkansas in North Little Rock — accepted the same collateral: Crawford’s contract with Los Angeles Laker Derek Fisher.

And last Monday, Bank of the Ozarks warned shareholders that it would take a $796,000 charge-off even after foreclosing on 32 properties it had bankrolled to the tune of $2.3 million for a single borrower. It was a painful conclusion to a case Arkansas Business first “whispered” about in June.

So the official word that banks have been lending with abandon came as no surprise. The question that remains for those of us who only know what we read in the papers is, “Why?”

I called up some bankers who in the past have been kind enough to help me look smart. “What’s the deal?” I asked. “I thought banking was more of a science than this.”

Higher interest rates, they said. What cash-flowed at 8 percent may not cash-flow three years later when it is refinanced at 9.5.

Aggressive competition for loans, they said. Be wary of any bank whose asset growth far outstrips growth in the market. There can’t be that many more good loans to make. “You’ll eventually pay for it,” one said.

Sloppy underwriting, they said. There’s no good excuse for multiple banks accepting the same collateral over and over, even small banks that consider lending as much art as science.

But primarily, they say, banking has a shortage of experience, something the industry has been hemorrhaging in the era of consolidation. “There’s a whole generation of lenders who have never lent in anything but a world-record economy,” said one old pro. “The first thing I look for in a lending department is gray hair,” said another.

The economic expansion and low interest rates of the 1990s have covered a multitude of underwriting sins. Lenders have made high-risk loans with impunity — even reward — and may not yet understand fully just how risky these things can be. But they are learning as the white-hot economy cools, as soft spots such as agriculture, poultry and trucking become increasingly obvious, and as competition compresses margins. There just aren’t as many fig leaves to hide behind as there used to be.

Cautionary tales abound in the pages of this and other business publications, and I’m afraid there are more to come. There are lenders in this town who are reading these stories and thinking, “There but for the grace of God…”

***

All this reminds me of an anecdote from my previous life producing publications for the bar association in Nashville, Tenn. A group of bankruptcy lawyers having a luncheon meeting in the conference room startled the staff by erupting into applause, complete with hooting and foot stomping. When the meeting broke up, I asked one of the bankruptcy lawyers what had caused all the cheering. He said the guest speaker had delivered excellent news: banks appeared to be relaxing their credit standards.

Excellent news for bankruptcy lawyers, that is.

(Gwen Moritz is editor of Arkansas Business. She can be reached via e-mail at gmoritz@abpg.com.)



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