Every commercial loan broker will tell you that the banks are not making a whole lot of commercial loans these days. Surprisingly, the reason why isn't just because they are afraid to make new commercial loans.
Another important reason is that many banks are fully-invested. In plain English, they simply don't have the money to make many new commercial loans.
This lack of liquidity is not the result of loan losses associated with the subprime meltdown. Few small banks were involved in the deal-flow of subprime loans. When the music suddenly stopped, the small banks were not left holding a huge volume of unsold subprime residential loans. It is easy, therefore, to assume that the small banks should have plenty of money to lend.
In fact, the opposite is true. Banks have always preferred to make short term loans, like construction loans and bridge loans. This way they constantly have a few outstanding loans paying off every month, giving them the liquidity to make new short term loans. Unfortunately, ever since the financial crisis began, their outstanding loans have not been paying off. Borrowers with construction loans and bridge loans have been unable to refinance their loans with long-term lenders. The banks have been forced to extend these short term loans into longer term mini-perms.
To make matters worse, most small banks had a great many lines of credit extended to businesses that they served. Most of these businesses are now losing money, so the businesses are drawing down on their credit lines. This has further drained liquidity from the banks.
Lastly, this is a very difficult time for banks to attract new deposits. The prime rate is a rock-bottom 3.25% right now. The 11th District Cost of Funds Index, a fair proxy for the typical bank's cost of funds, is a whopping 2.75%. Twenty years ago a small bank could not survive on a gross interest margin of less than 6%. With sophisticated new software and ATM's, a small bank can modernly make a profit on a gross interest margin of 4%. Hello? Small banks are being forced to survive right now on a gross interest margin of just 50 basis points. They certainly cannot raise interest rates to compete for more deposits.
I feel like an early pioneer, whose wagon train is surrounded by angry Indians, and who learns that the cavalry detachment sent to relieve him is itself under siege by Indians. The small banks were one of the last sources of lending that might save this faltering economy, and it now appears they too are under siege. Yikes.
G. Blackburne
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