In soft economy, businesses face uphill battle for loans

REGION – The national credit crunch has rolled into the region, making it harder for many businesses to take out loans and putting up more hoops for them to go through.

Bankers say they have money to lend and basically haven't changed their underwriting standards. In practice, however, it's clear that businesses are generally facing tougher loan conditions. Cash flow and property values are both generally down, reducing customers' ability to borrow. And, in some cases, the deterioration of their industries affects their prospects.

The Federal Deposit Insurance Corp. has also begun requiring banks to insist on minimum credit scores of 660 for most commercial borrowers – instead of 620 previously.

In addition, some large banks in Michigan are apparently trying to steer clear of distressed industries such as commercial real estate, construction, and manufacturing, especially for the auto industry.

"Some of the bankers will privately tell you that their banks aren't focusing on real estate loans in Michigan," said Rick Deneweth, managing member at Three West LLC, a commercial real estate developer.

Current commercial floating interest rates, often in the five percent range, are quite affordable by historical standards. But local borrowers haven't been able to totally capitalize on the Federal Reserve Bank's efforts to infuse the U.S. economy with cash.

Even with the prime rate at a low 3.25 percent – the rate that major banks charge their best corporate customers – many banks won't go below five percent on floating rate loans – generally the least expensive loans available – since they are paying out nearly the equivalent rates on certificates of deposit in some cases.

But a 5, 6 or 7 percent loan rate is still a far cry from the rates of 20 percent or more in the late 1970s and early 1980s when inflation ran rampant, notes Connie Deneweth, CEO of Traverse City State Bank, who sits on the other side of the great lender/borrower divide from husband Rick.

Dan Druskovich, vice president of commercial loans at Northwestern Bank, said it's hard to generalize about rates since they depend on the borrower's circumstances and track record. And banks are hedging their bets by setting fairly high rates on long-term, fixed rate loans.

An interest rate of 10 percent might be a little higher than banks would be ready to go even in today's brutal economy, Druskovich said, when asked about the potential upper limit on rates.

"But the point is, the longer you try to lock in the money, the higher it is going to be. Somehow banks have to protect themselves to try to remain profitable."

From the bank's standpoint, a long-term, fixed rate takes some of the uncertainty out of the equation.

"They have held relatively steady due to the uncertainty of the marketplace," Druskovich adds. It is hard for banks to lower fixed rates given the risks of inflation over the next three to five years.

If borrowers are willing to take a risk, they can get a low rate on a floating basis. But they then face a higher rate if the prime rate rises.

So far, the financial crisis and recession haven't resulted in a general loan drought in northern Michigan – at least as far as the latest figures from the Federal Financial Institutions Examination Council (FFIEC) indicate.

Loan volumes of northern Michigan banks actually rose through the end of 2008, and that increase held up for Northwestern Bank through the first two months of 2009, according to Druskovich and figures from the FFIEC. He added that Northwestern isn't cutting back on loans arbitrarily.

"You hear these stories about other financial institutions calling people up and saying, 'By the way, instead of a $100,000 line of credit, you have a $25,000 line of credit.' Well we aren't doing that," he said.

Connie Deneweth says Traverse City State Bank has seen a number of new customers whose old loans have been terminated by institutions that are "reducing their exposure" to industries such as construction and manufacturing.

But even at her bank, the lending standards are somewhat tighter, she said.

"Unfortunately, there are fewer people who qualify," she said. Cash flow is sometimes falling in tandem with property values. "The profitability of businesses has been reduced, and the cushion that we require is higher than it used to be – maybe another 10 to 20 percent.

"We not only like to see the customer be able to make the payment. We like to see the customer have a little bit of extra cushion."

The issue of the customers' character may crop often up in tough economic times, even though this is hard to measure.

"When people's backs are against the wall, their behavior sometimes reflects character," Deneweth said. "They sometimes do things that they wouldn't normally do."

One example could be excessive litigation. Banks might think twice about lending to someone who is prone to file lawsuits. "It goes to their character," she said. "I am not saying that suing someone is a reason for a loan denial. But it suggests how some people behave in certain situations and how other people don't."

Bankers acknowledge that declining cash flow and business and property values have often reduced their clients' general creditworthiness. This could reduce the flow of credit to some businesses even without tougher underwriting – the process of verifying a borrower's data and determining the likelihood of the repayment of a loan.

"Obviously, if a customer's business performance has changed significantly, we might have to make a change just to be prudent lenders," Druskovich said.

That calculation is likely to apply to more than just a handful of borrowers today.

"Everybody's circumstances have changed," said Mark Eckhoff, president of FifthThird Bank in Traverse City. "If you were to walk up and down Front Street and talk to merchants, they would say they are not seeing the kind of spending they have seen in years past, although I am sure there are some exceptions."

Due to the soft economy, loan requests are down, too, he said.

"This recession is pretty broad, and it's not hitting just a handful of sectors. Most folks are just trying to ride this out."

Rick Deneweth sees the effects of lower property appraisals on his business as well as on other companies.

"In the past, you might have been able to rely on equity in a prior project to finance to provide collateral in a new project," he said. "Well, if the appraisal on that existing project comes in low, you have lost that collateral." He also said banks are generally looking for higher down payments on purchases.

One positive factor is that commercial loans aren't in the same boat as residential.

"I would say that the commercial properties that we have looked at recently have not declined as quickly as the residential market," said John Gray, president of First Community Bank. "But there certainly is a downward pressure on commercial real estate values."

Randy Williams, regional market president at Irwin Union, says his bank refocused its business on small businesses and consumers in 2006 – and it hasn't made a change this year. It is ready to approve real estate loans for owner-occupied buildings, whether they are residential or commercial, he said.

"We have predominantly been conservative, although there are probably a few industries we would look a little more closely at right now," he said. "There are certainly circumstances out there that are hard for lenders to assist people with." BN