Brainstorming the Box: How would you solve the frozen wasteland of lending origination?

So here we are in May 2009 with banks being commanded by the Fed to raise capital against the possibility of even deeper erosions in the U.S. economy. The government has a strategy for putting toxic securities on ice some pressure off Wall Street but so far not restoring confidence in it.

So now this exposes the next scab. The banks with the largest "main street" lending exposures still face the possibility of dealing with staggering loss provisions and possibly loss realizations. A flight to quality is the order of the day but one cannot live only on lean meat forever.

Banks ultimately earn their bread and butter living by charging periodic interest on lending. No new lending origination, no new sources of income. So what would you do to get main street access to lending moving again? At the big bank level? At the little bank level? On the finance side?

What's the recovery conversation on this one?

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Permalink Reply by Gary Schurman on May 13, 2009 at 10:36am: Bank values are driven by return on equity (assets x asset yield / capital) so in normal times there is the incentive to increase earning assets (i.e. lend) while keeping the capital balance fixed thus increasing ROE, which increases bank value. You can look at total bank capital as loss reserves plus equity. Reserves cover expected losses while capital covers unexpected losses. If you are comfortable with your level of loss reserves then the capital balance can be levered up to maximize ROE. That being said, these are not normal times. Banks are unsure as to how much of their capital (unexpected loss cushion) should be allocated to loss reserves (expected loss coverage). Until the recovery takes hold banks will not be comfortable with their level of loss reserves vs capital. Once they reach this comfort level (i.e. loss reserves are adequate and the remaining capital is free to be levered up) then they will start lending. Until then its capital preservation at all cost.

My guess> banks will start lending once a recovery is firmly in place and the expected loss number can be estimated with a reasonable amount of certainty. Until then banks won't lend regardless of what the government does (TARP, buying toxic assets, etc.); ▶ Reply to This

Permalink Reply by Tom Burke on May 13, 2009 at 2:52pm: Heh, heh. Gary is undoubtedly right. The banks will start lending the money again when the recovery is firmly in place. In other words, as long as you don't need money, we'll lend you as much as you want. Stop me if you've heard that before.; ▶ Reply to This

Permalink Reply by Ward Harrington on May 14, 2009 at 1:18am: Maybe some enlightened bank will decide to "talk the walk" the way the FDIC taught me in the early 80s.

I was working for what was then the largest bailout in history (before ContIlli), and the FDIC was giving us some of the greatest learning experiences anybody could hope for. One of their hobby horses was having the branch based commercial lenders walk the neighborhoods adjacent to our branches looking for prospective customers.

The idea was that if we could see the prospect in real life, we would be able to decide whether or not there was a future in starting or expanding a relationship. Just behind that idea was the presumption that, if something went wrong, it was easy enough to go to the source.

We picked up an immense amount of highly profitable business by doing this. The payoff came from putting all of our lending into relationships that were likely to be productive, rather than to sling "product" at anybody who seemed to meet "program criteria."

The good news is that we paid off the FDIC, which nobody expected could ever have happened. The bad news was that, as soon as the FDIC cleared out, it was bon temps roulez all over again and the place was merged, under the FDIC's unforgiving eye, into a competitor soon afterward.

Wanna talk ROE? Lending to strong customers you've already borne the acquisition cost on can be a very high-yield proposition if you play your cards right. Lending to prospects in businesses you understand in areas you understand runs a close second. Selling loans as if they were toasters is, well, probably going to toast somebody.; ▶ Reply to This

Permalink Reply by Dennis Santiago on May 14, 2009 at 2:53am: I like the MBWA thought a lot.; ▶ Reply to This

Permalink Reply by JJ Hornblass on May 14, 2009 at 5:00pm: I'd add just one other factor: investor demand. Return on capital is a powerful motivator to take on risk, and while investors are largely sitting on the sidelines now, they won't forever. And they might not wait for "a recovery firmly in place" to put their capital to work.

On another note, maybe it should be LBWA, not MBWA?; ▶ Reply to This