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The New Normal: How to Achieve Profitable C&I Loan Growth in Today's Economy

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The New Normal: How to Achieve Profitable C&I Loan Growth in Today's Economy

  1. 1. Presented by: Justin Barr | BankDATAWORKS.com Michael Iannaccone | MDI Investments Jon Winick | Clark Street Capital
  2. 2.    Financial information company that provides credit and risk management solutions to financial institutions Data and applications used by thousands of financial institutions and accounting firms across North America Awards ◦ Named to Inc. 500 list of fastest growing privately held companies in the U.S. ◦ Named to Deloitte’s Technology Fast 500
  3. 3.  Web based subscription service that produces cutting-edge banking industry:  REPORTS that deliver comprehensive current period and historical financial data and analytics on all U.S. banks and hundreds of banking markets across the country in a familiar Microsoft Excel® format.  NEWS ARTICLES that deliver plain English narrative and graphical analysis of hundreds of U.S. banking markets and identify top and bottom performing banks in each market - produced under exclusive contract with data-to-narrative artificial intelligence software leader Narrative Science, Inc.  Complimentary 1-yr. subscriptions available to Sageworks’ bank clients.
  4. 4.    Justin Barr, President. Mr. Barr is widely recognized as an expert on the community banking industry and is often quoted by leading financial industry media outlets. Mr. Barr is a third generation Chicago banker and second generation commercial lender and bank turnaround expert. Mr. Barr also manages a C&I lending focused bank partnership program for BankDATAWORKS’ parent company Franklin Capital Network, a national commercial finance company. Michael Iannaccone, Member-Advisory Committee. Mr. Iannaccone, founder and President of MDI Investments, Inc., is a seasoned investment banker who is widely recognized as an expert on the community banking industry and is regularly quoted by leading financial media outlets. Jon Winick, Member-Advisory Committee. Mr. Winick, founder and President of Clark Street Capital Management, LLC, is a nationally recognized expert on the SBA 7(a) and 504 lending programs and currently serves as Chairman of SomerCor 504, a leading originator of SBA 504 loans in Chicago and Illinois.
  5. 5.  U.S. ECONOMIC OVERVIEW  U.S. BANKING SECTOR OVERVIEW ◦ REVENUE AND EARNINGS PERFORMANCE ◦ LENDING ENVIRONMENT  NICHE C&I LENDING STRATEGIES ◦ ACCOUNTS RECEIVABLE FACTORING  CASE STUDY: CRESTMARK BANK ◦ SBA 7(a) LENDING  CASE STUDY: LIVE OAK BANKING COMPANY ◦ BUY / BUILD / JOINT VENTURE ALTERNATIVES
  6. 6.    U.S. economy continues to grow, but at a sluggish pace. Nearly three years into the recovery, gross domestic product (GDP) is about 7 percent above its recession trough but barely above its pre-recession level. Employment growth has been uneven in 2012 and remains below expectations.
  7. 7.  Economic outlook is uncertain due to: ◦ ◦ ◦ ◦ Continued labor market weakness. Ongoing Eurozone crisis. Slowing in emerging markets. U.S. fiscal situation. • Consensus private sector forecast suggests unemployment will remain above normal through 2013. • Slow recovery implies slow growth in spending and loan activity.
  8. 8.  Revenues remain relatively flat. ◦ YTD Gross Revenue ↓0.9% YOY @ 9/30/2012  Net income improving, at same levels as in 2005 and 2006, driven by lower provisions and charge-offs. ◦ YTD Net Income ↑13.7% YOY @ 9/30/2012 ◦ YTD ALLL Provision ↓23.2% YOY @ 9/30/2012 ◦ YTD Net Income ↓25.6% YOY @ 9/30/2012
  9. 9.   ROA and ROE improving but well below long-term averages. Net interest margin remains under pressure, but for larger banks is higher today than in 2007. ◦ Low interest rate environment likely to persist. ◦ As older, higher margin assets mature or default, they are replaced by lower yielding instruments.
  10. 10. Banking Sector Overview Lending Environment  Loan to deposit ratios at historic lows.  Loan portfolios remain real estate heavy. ◦ 54% of total loans @ 9/30/2012  Real estate loan growth remains relatively weak. ◦ ↑1.1% YOY @ 9/30/2012  C&I loans showing strong growth. ◦ ↑14.7% YOY @ 9/30/2012 ◦ Growth centered on loans over $1MM.  Loan demand from larger businesses is growing.  Loan demand from small businesses continues to lag.
  11. 11. Banking Sector Overview Lending Environment (continued)  C&I loan competition intense and increasing.  C&I loan underwriting standards easing. ◦ Net easing for 8 consecutive quarters  C&I loan rate spreads decreasing. ◦ 60% of bankers surveyed report ↓ spreads for loans to larger businesses. ◦ 46% of bankers surveyed report ↓ spreads for loans to small businesses.  Regulatory authorities increasing exam scrutiny of C&I lending practices.
  12. 12. DEPOSITORY GOVERNMENTS, 1.2% ALL OTHER, 4.9% LEASE FINANCING RECEIVABLES, 1.4% INSTITUTIONS, 1.4% AGRICULTURAL PRODUCTION, 0.9% RESIDENTIAL REAL ESTATE, 24.9% CONSUMER, 17.1% COMMERCIAL REAL ESTATE, 14.0% COMMERCIAL AND CONSTRUCTION AND INDUSTRIAL, 19.2% DEVELOPMENT REAL ESTATE, 2.8% RESIDENTIAL REAL ESTATE OTHER REAL ESTATE, 0.8% MULTI-FAMILY REAL FAMLAND, 0.9% ESTATE, 3.0% - HOME EQUITY LOANS, 7.5%
  13. 13. 70% 60% 50% 52% 53% 55% 59% 59% 62% 62% 61% 59% 61% 58% 56% 54% REAL ESTATE SECURED LOANS 40% 30% 20% 10% 0% COMMERCIAL & INDUSTRIAL LOANS CONSUMER LOANS 23% 22% 19% 17% 16% 16% 16% 18% 19% 17% 16% 17% 19% FARM LOANS OTHER LOANS LEASES
  14. 14. Niche C&I Lending Strategies The Challenge   The real estate meltdown has made clear the need for diversified credit risk and cash flows. In response, many banks have moved to balance real estate loan concentrations through C&I loan growth but face considerable challenges, including: ◦ Intensifying competition, causing tightening spreads and loosening structures. ◦ Weak loan demand from qualifying borrowers. ◦ Regulatory scrutiny of new C&I loan business, especially for new market entrants.
  15. 15. ACCOUNTS RECEIVABLE FACTORING
  16. 16.  Lending Strategy focused on accounts receivable factoring. Established in 1996. Privately held. Headquartered in Troy, MI.  Financial Snapshot 9/30/2012:   ◦ Single deposit taking location. ◦ Total Assets: ◦ Total Loans: ◦ ◦ ◦ ◦  C&I Loans: $407.1MM $367.9MM (∧13.6% YOY) $344.2MM (93.5%) YTD Net Income: $8.8MM Annualized, YTD ROA: 3.0% Annualized YTD ROE: 24.7% Well capitalized (all ratios)
  17. 17. 3.50% 3.20% 2.99% 2.86% 3.00% 2.50% 2.00% 1.53% Crestmark Bank ROA 1.50% Average ROA (All FDIC Insured Banks) 1.02% 1.00% 0.50% 0.34% 0.24% -0.03% 0.00% 2008 -0.50% 0.61% 0.46% 2009 2010 2011 3Q 2012
  18. 18. 30.00% 26.92% 24.67% 25.00% 22.97% 20.00% 15.00% 12.40% Crestmark Bank ROE 9.03% 10.00% 5.00% 3.72% 2.45% 1.89% -1.27% 0.00% 2008 -5.00% 1.26% 2009 2010 2011 3Q 2012 Average ROE (All FDIC Insured Banks)
  19. 19. Niche C&I Lending Strategies: A/R Factoring Key Attributes to Lender  Ownership of and control over the A/R portfolio and cash ◦ Account debtors notified to pay lender pursuant to UCC9-406(a). ◦ A/R payments sent directly to lender lockbox or P.O. box. ◦ A/R excluded from company’s estate in the context of bankruptcy.  Funding decisions predicated on in-depth, real-time, verified A/R data ◦ Each individual invoice is ledgered in and tracked by specialized MIS. ◦ Invoices with supporting documents evidencing delivery sent to lender by borrower. ◦ 70-80% of invoices directly verified with account debtors. ◦ Lender creates real-time, verified eligibility schedules and borrowing base certificates.
  20. 20. Niche C&I Lending Strategies: A/R Factoring Key Attributes to Lender (continued)  Strong A/R liquidation outcomes due to relationships with individual account debtors, verifications and credit limits. ◦ Lender has outsourced A/R department and develops relationships with account debtor A/P personnel. ◦ Hard to dispute an invoice that’s been verified as good. ◦ Initial and ongoing underwriting of individual account debtors.  Establishment of credit limits where appropriate.   Extraordinary insight into integrity of operations of borrower. Applicable to a significantly underserved market segment with yields significantly in excess of traditional C&I lending.
  21. 21. Niche C&I Lending Strategies: A/R Factoring Key Attributes to ‘Borrower’     Immediate access to greater working capital. Faster over-line decisions due to robust, real time collateral information and insight into operations of borrower. Enhanced customer credit information and decision making. Enhanced monitoring and collection of A/R portfolio resulting in declination of days sales outstanding.
  22. 22.  Most asset based loans to small and midsize companies should be structured as factoring accommodations. • Traditional, company prepared borrowing base certificate data is not real-time and is generally inaccurate. • If assets of most small to mid-size companies were marked-to-market, companies would have a negative tangible net worth. • Current market pricing for bankable ABL deals is not (at all) commensurate with risks.
  23. 23. Niche C&I Lending Strategies: A/R Factoring Target Markets  Business-to-business companies that otherwise do not qualify for traditional bank financing or require financing in excess of what is available through such financing. ◦ Early stage companies ◦ Companies outgrowing their capital base ◦ Companies in a turnaround mode  Small & midsize companies with unconditional sales and verifiable invoices, except: ◦ Because of progress payments, construction industry not eligible ◦ Medical receivables for services to patients not eligible
  24. 24. SBA 7(a) Loan Program
  25. 25.  Lending strategy exclusively focused on SBA 7(a). In 2012, 4th largest 7(a) lender nationally having originated 489 new 7(a) loans during the year with an aggregate principal balance of $463MM. Established in 2008. Privately held. Headquartered in Wilmington, NC.  Financial Snapshot @ 9/30/2012:   ◦ Single deposit taking location. ◦ Total Assets: ◦ Total Loans: ◦ ◦ ◦ ◦  C&I Loans: $320.7MM $230.8MM (↑25.6% YOY) $79.4MM (34.6%) YTD Net Income: $11.6MM Annualized, YTD ROA: 5.3% Annualized, YTD ROE: 44.1% Well capitalized (all ratios)
  26. 26. 7.00% 6.16% 6.00% 5.29% 5.00% 4.62% 4.00% Live Oak Banking Company ROA 3.00% 2.00% Average ROA (All FDIC Insured Banks) 1.84% 1.02% 1.00% 0.00% 0.34% -0.03% 2009 -1.00% 0.61% 2010 2011 3Q 2012
  27. 27. 70.00% 60.00% 57.38% 50.00% 51.99% 40.00% 44.11% Live Oak Banking Company ROE 30.00% Average ROE (All FDIC Insured Banks) 20.00% 20.11% 9.03% 10.00% 0.00% -1.27% 2009 -10.00% 1.26% 1.89% 2010 2011 3Q 2012
  28. 28. Niche C&I Lending Strategies: SBA 7(a) Overview    Largest SBA lending program. Designed to finance businesses that otherwise would not qualify for bank financing through 75% SBA guaranty. Loan volume statistics 2007 – 2011: $60.0 B I L L I $50.0 $40.0 $46.1 $47.7 $48.6 $50.8 $55.2 7(a) Loans Approved $30.0 O N $10.0 7(a) Loans Outstanding $20.0 S $19.6 $14.3 $12.7 $2007 2008 $9.2 2009 $12.4 2010 2011
  29. 29. Niche C&I Lending Strategies: SBA 7(a) Key Attributes to Bank  Reduce loan portfolio risk, while increasing profitability. ◦ Reduce Risk. 75% guaranty of the outstanding loan balance by the US Federal Government. ◦ Increase Profitability. The guaranteed portion of an SBA loan (75%) can be sold into an active secondary market at a substantial premium.  Improve capital ratios. ◦ Bank only needs to pledge reserves against the unguaranteed portion of the loan (25%).
  30. 30.  Increase Eligible Loan Size ◦ Only the unguaranteed portion of the loan (25%) needs to be counted against the Bank’s legal lending limit to one borrower rule.  Reduce Concentration Exposure and/or Exposure to Stressed C&I Credits ◦ Existing performing C&I loans that meet certain criteria can be refinanced and 75% guaranteed portion sold at a substantial premium, regardless of collateral coverage.
  31. 31. Niche C&I Lending Strategies: SBA 7(a) Key Attributes to Borrower Longer terms with lower payments.  Fully amortizing: no calls or balloons.  Full collateral coverage is not required.  Lower equity contributions.  No prepayment penalty for loans with a maturity of <15 years. 
  32. 32. Niche C&I Lending Strategies: SBA 7(a) Loan Terms  Guarantee Percentage: ◦ 75% guarantee on loans over $150,000  Rate: ◦ Max. floating rate of P+ 2.75% on loans <$150,000  Maturity: ◦ Intangibles (working capital, goodwill) – 10 yrs. ◦ Equipment – 10 yrs. (can be longer given useful life appraisal) ◦ Real Estate – 25 years  Amortization: ◦ Fully amortizing, no calls or balloons
  33. 33. Niche C&I Lending Strategies: SBA 7(a) Loan Terms  Prepayment Penalty (retained by SBA):  Collateral Advance Rates:  Personal Guarantees: ◦ Term <15 years – None ◦ Term >15 years – 5/3/1 ◦ N/A. But lender must take all ‘available’ collateral using advance rates at the bank from similar sized conventional loans. ◦ An assignment of life insurance is required on all loans that are not fully collateralized by commercial real estate (M&E under some circumstances) ◦ Junior lien on personal residence required on all loans that are not fully collateralized and where the residence has equity. ◦ Full and unlimited personal guarantees from all owners of 20%+.
  34. 34.  Business Acquisition:  Real Estate: Purchase, Refinance or Construction: ◦ Requires 3rd party valuation. ◦ Generally requires 25% equity. Equity can be in the form of cash from the buyer (funds may not be borrowed) or seller financing. If seller note is being used as equity, then it must be on full standby for at least 2-years (i.e. subordinated w/ PIK interest). ◦ All transactions with CRE taken as collateral require 3rd party appraisal and applicable environmental study.  Refinance:  Equipment: Purchase or Refinance  Working Capital ◦ Any business related debt, other than shareholder notes ◦ Term can exceed 10-yrs. if supported by 3rd party appraisal.
  35. 35. Must be a legal, for profit entity .  Based in the U.S.  A Small Business (<$3.5 million income and <$15 million net worth) .  Commercial real estate must be 51% owner occupied (60% for new construction).  Principals must be of “good character” and legal U.S. citizens or residents. 
  36. 36.  Per the SBA, ‘prudent’ lending standards govern SBA 7(a) loan underwriting. The guarantee cannot be used to replace the reasonable credit judgment and prudent underwriting policies that would be used on similar size conventional loans by the bank. ◦ No minimum debt service coverage ratios, but the primary source of repayment on the loan must be the cash flow of the business and not liquidation of collateral or personal resources of guarantor. ◦ Financial covenants and reporting requirements should be included as necessary. However, a loan may generally only be accelerated for payment default. ◦ No required minimums on FICO scores. However, it is imperative that the bank follow prudent lending standards.
  37. 37.  BUY ◦ Benefits:  Immediate market impact.  Predictable performance metrics.  Meets regulatory mandates regarding control processes, systems and human resource talent. ◦ Risks:  Significant up-front cost, including likely goodwill.  Permanent.  Potential for culture clash.
  38. 38.  BUILD ◦ Benefits:  Control.  Ability to ensure cultural consistency. ◦ Risks:  Delayed and uncertain market impact.  Significant up-front cost to acquire systems and human resource talent.  Potential regulatory issues regarding lack institutional business line experience.
  39. 39.  JOINT VENTURE ◦ Benefits:       Immediate market impact. Variable cost. Improves efficiency ratio. Ability to test effectiveness of business model. Bridge to building in-house capability. Meets regulatory mandates regarding control processes, systems and human resource talent. ◦ Risks:  Reputation of J/V partner has potential to taint that of bank.  Exclusivity not necessarily ensured.
  40. 40.  Justin Barr, BankDATAWORKS.com ◦ (888) 701-1500 | Jbarr@BankDATAWORKS.com  Michael Iannaccone, MDI Investments ◦ (708) 445-7238 | Michael@MDIinvestments.com  Jon Winick, Clark Street Capital ◦ (312) 662-1500 | Jon.Winick@ClarkStCapital.com  Sageworks, Inc. ◦ (919) 851-7474 x619 | Billy.Burnet@SageworksInc.com

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