Paul Davis is a contributing writer for Bank Director. He previously served as director of market intelligence at Strategic Resource Management, editor of community banking and M&A at American Banker, and news director at SNL Financial.
More Banks Are Reporting Slowing Loan Growth, Raising Risk Concerns for Directors
Boards need to understand that pressure to keep pipelines flowing could lead to credit-related headaches in the future.
There are increasing signs that consumer and business loan demand is slowing down – directors should take note and prep questions for their management teams. A survey conducted by IntraFi in early July found that nearly 40% of respondents had seen a decrease in loan demand compared to a year earlier.
Several large and midsize banks warned during their second quarter earnings calls recently that appetite for loans has cooled, and a few community banks reported linked-quarter declines in loans outstanding.
Anticipation of decelerated loan growth came up frequently in those calls, says Christopher Marinac, the director of research at Janney Montgomery Scott. Loan demand is largely falling because of persistently high interest rates, while more banks are trying to be more cautious, he says. “Generally, loan growth is slow coming out of second-quarter earnings reports so far,” Marinac says, noting that several banks have lowered their year-over-year forecasts.
Texas Capital Bancshares in Dallas recently was among the banks to warn about a lending slowdown. The company cut its 2024 revenue growth forecast to a low- to mid-single digit increase from the mid-single-digit projection it provided in January. “I think the biggest difference halfway through the year … has really just been client appetite for bank credit,” said Matt Scurlock, the $29.9 billion company’s chief financial officer, during a call to discuss quarterly earnings. Loan growth is “a bit more challenging” because of high interest rates, he added.
With that in mind, boards need to understand that any pressure to keep lending pipelines flowing could lead to credit-related headaches down the road. That should serve as motivation to ask the right questions now to help keep their banks from making such missteps.
Understanding Why
A key consideration for directors should involve understanding the underlying causes of decelerated loan growth. It could be reduced appetite by potential borrowers or a concerted effort by bank executives to be more cautious. “There is a mix of banks being careful and customer demand being somewhat limited,” Marinac says.
To that point, banks that did report linked-quarter declines in outstanding loans had different messages during their quarterly calls. “We’ve de-emphasized asset growth,” said Edward Handy III, chairman and CEO at Washington Trust Bancorp, during the Westerly, Rhode Island company’s earnings call. The $7.2 billion company, which reported a $56 million, or 1%, decline in loans from the first to the second quarter, instead is focusing on building capital and adding deposits.
Enterprise Financial Services Corp in St. Louis, where loans fell slightly, by $28.5 million from the first quarter, said the decline was due to lower line usage, higher paydowns and the rundown of its agriculture portfolio. The expectation is for “strong loan origination activity” over the second half of this year, Jim Lally, Enterprise’s CEO, told analysts during the $14.6 billion company’s earnings call.
Focus on Lending Officers
A big focus for directors should be on a bank’s lending officers. Boards need to press executives to get a better understanding of how lenders are compensated to emphasize solid underwriting and limit how many exceptions are made to land a borrower relationship.
It can be tempting to compromise on loan terms when a portion of compensation is tied to a lender’s pipeline, says Allen Puwalski, managing partner and chief investment officer at Cybiont Capital, who joined New York Community Bancorp’s board earlier this year.
“Regulators are very focused on compensation packages, so make sure you have the right risk-rewards built into those packages,” says Puwalski, who declined to specifically discuss New York Community. “When loan demand weakens it is the perfect time to expect your compensated staff to want to keep volume up, so it is important to go over the compensation policies with management.”
Boards should also ask management teams to discuss the lending deals they have been turning away, understand which competitors are picking up the deals and what terms are being conceded by those other lenders.
“Competing on terms can be a minefield,” Puwalski says. “Engage in a conversation about why they are losing deals. If they tell you that they haven’t lost any — you should ask them why not.”
Banks have been changing pay structures to reward bankers for bringing in more deposits, according to a recent Bank Director article.
Enforce a Disciplined Culture
Another task for directors involves making sure executives avoid big strategic missteps, which could include out-of-market lending or entering new business lines.
“People often fool themselves into doing something that they shouldn’t — or can’t — do,” says Yousef Valine, retired chief operating and risk officer at $82.2 billion First Horizon Corp. in Memphis, Tennessee, who is now a director at $11.9 billion Live Oak Bancshares in Wilmington, North Carolina. “They enter into and invest in a vertical, but then they end up experiencing losses that are out of proportion.” Valine was discussing the industry broadly, not Live Oak.
Examples in recent years include banks getting into — then exiting — sectors such as energy, healthcare and transportation. “There are plenty of people, even some at big, sophisticated banks, that have gotten into situations like this,” Valine says.
Another thing to watch is concentration limits, as they relate to risk-based capital, in specific lending categories. The key is to avoid so-called mission creep, where gradual shifts can lead to jarring negative consequences.
Directors should keep a watchful eye on the composition of the bank’s entire loan portfolio. For instance, a bank that might have an historic cap of 200% commercial real estate loans as a percentage of total risk-based capital might inch closer to 250% — presenting an opportunity to have a boardroom conversation. Regulators tend to scrutinize banks where CRE concentrations exceed 300% of total risk-based capital if those loans grew by 50% or more during the past 36 months.
“Management may make the case that they know how to approach that loan category and be diligent as the concentration rises,” Valine says. “That’s a good time to ask, ‘Should we be doing this?’”
To be sure, credit metrics remain relatively good at most banks. Still, asking the right questions now can mitigate future issues by making sure lenders avoid overreaching to keep loans flowing into the bank. “That’s a very thoughtful way of thinking about the pace of loan growth,” Marinac says.