Tag Archives: bank loans

Bank Lending Break Through?

Bank lending seems to be back in action again. Banks all around have been on a stand still waiting for loan growth to pick up. Although the winter provoked a minor drawback, loan growth is what banks need to get the ball rolling. Without these loans, banks have had to try “to bolster earnings through repeated rounds of cost cutting and reversals of loan-loss reserves.” While loan growth seen in the first quarter isn’t a clear indication that we are back on track, it does provide signs that the lending environment is in fact improving. Although all the results have not been accounted for yet, the latest data has shown that overall bank loans grew from a year earlier at an average of 2.5%.

This pace is very similar to what occurred in the final quarter of 2013. As you can see in the FRED graph, there was a strong increase in the total value of loans towards the end of 2013.

While this may look rather attractive, but there is still room for improvement. These rates and values can decrease very quickly, especially if lenders are holding too much collateral. This means that our economy needs to continue to move forward and it all depends on how the Fed decides to solve the problem for banks. Michael Ivanovitch writes, in a CNBC article, that he believes the Fed is aware of the situation we are currently in; currently there is still weak bank lending, which is stalling our growth in the U.S.

“Monthly asset purchases—on top of a virtually zero percent interest rate—have been a relatively easy part of a sweeping crisis management. The verdict on that policy is given by America’s demand, output and employment. It is perhaps time to adjust policy instruments and intermediation techniques to address some apparently structural issues whose solution does not seem to be in the wall of money thrown at the U.S. economy.”

While we at least have seen a stabilization following a long period of declining rates of loan growth, this is something we must still be aware of. The FRED graph has been allowed a number of interpretations to be good for the economy, but there are still weaknesses. Housing has begun to cool is recent pace and we are nowhere near enough to offset the losses already incurred. What I believe will keep our economy stable for the summer months will be a couple key decisions made by the Fed and how investors will respond to all the recent buzz. If nobody gets too anxious and jumps the gun, banks will be confident in lending allowing for an increased pace in our economy.

U.S. Bank Loans – A Random Walk Down Wall Street

P1-BO950_BANKLO_G_20140130185404

 

A post on Wall Street Journal early this year (Jan. 30), banks in the U.S. are beginning to loosen their tight grip on lending which made it easier for individuals or businesses to borrow, as we can see from the above graph.

The easing carried risks, including a return to the type of lax underwriting standards that would lead to crisis. According to A Random Walk Down Wall Street (P.197), “Risk is the probable dispersion of future returns.” Therefore, the more banks loan, naturally there is going to be more risk. The good thing is that risk and return are related – higher risk is the price one pays for more generous returns, as mentioned in the book (P.361). In the case where banks’ risk appetite grows, the return will also increase respectively given that the default rate is relatively tolerable.

It’s really important for banks to control that risk. We can apply some of the asset-allocation principles to the banks’ strategies in dealing with risk (banks lending money to earn interests is similar to investments for future return). As said in the book (P.371), “You must distinguish between your attitude toward and your capacity for risk. The risks you can afford to take depend on your total financial situation, including the types and sources of your income exclusive of investment income.” Considered the situation of banks, they did a bunch of research on their financial situation and realized that the easing should be extended to credit-card, auto and large corporate loans but not yet to residential mortgages and home-equity loans. Hence, among the changes banks are offering to entice customers: less onerous conditions for corporate borrowers to meet, giving banks fewer tools if a loan gets in trouble and longer terms for auto loans. The choices of what to be included is the process of “make sure the shoe fits and understand your objectives” (P.318).

Banks lending for loan interests is like “buy low, sell high” – buying is when they lend the money out while selling is when getting paid from the interests therefore earning the gap between lending and loan payments. This thought derived from the efficient-market theory mentioned in the book (P. 186). The efficient-market theory tells that intelligent people are constantly shopping around for good value, they tend to favor those will turn out to be overvalued in the future but currently undervalued. The banks will lend the money to the person/business most of the time when they think the person or the business has the ability to earn more in the future or at least have the ability to pay back loans plus interests.

Lastly, the book tells that in order to avoid sinkholes, we need to diversify our investments. This applied to bank loans as well. Banks should diversify the industries they are lending, as they already did, in credit-card, auto and large corporate loans. Therefore, if some industries are suffering a bad time, the possible lost of interests payments could be offset by the gains from the rest.

Securing a Bank Loan for a Start-Up

When an entrepreneur is not provided with sufficient venture capital funding for the growth of a start-up, they often have to look to banks in the hopes of securing a bank loan. However, since most first time entrepreneurs do not have a proven track record of success, start-ups can appear as a very high-risk investment. Because of this, most banks are hesitant to give out loans given the high rate of failure for start-ups. On the Wall Street Journal Radio, Sarah Needleman states that an entrepreneur generally has a better shot at securing a bank loan when considering buying an existing business. This way, the bank can look at that company’s financial history and if they have a strong performance, that’s something an entrepreneur could use to their advantage. So, rather than starting something from scratch, an entrepreneur may either want to buy an existing business or even seek to buy a franchise. Even if starting a franchise from scratch, since franchises have proven business models, they tend to be more attractive to lenders.

A perfect example of this is Becky Cinti’s story as depicted in the WSJ. After spending twenty years working at bookstores, she decided that she wanted to open a bookstore of her own. Lacking sufficient start-up capital, she sought out a bank loan to cover initial rent and expenses. Since the economy was in the midst of the Great Recession, she got rejected. However, even as the economy turned around, her attempts to get a bank loan still failed. Banks saw bookstores as becoming obsolete in the near future. When a bookstore came up for sale in the area, Cinti applied again for a loan and this time she got it. This is a classic example of the challenges that a first time entrepreneur faces. No matter how great of a state the economy may be in, securing a bank loan can be tough.

Now, there is evidence that venture-backed start-ups fail at far higher numbers than the rate the industry usually cites. According to recent research by Shikhar Ghosh, a senior lecturer at Harvard Business School, “about three quarters of venture-backed firms in the U.S. do not return investors’ capital.” The common rule of thumb is that out of 10 start-ups, only three or four fail completely. Another three or four return the original investment, and one or two produce substantial returns. So really, there are different definitions of failure. Based on Ghosh’s research, “if failure means liquidating all assets, with investors losing all their money, an estimated 30% to 40% of high potential U.S. start-ups fail, he says. If failure is defined as failing to see the projected return on investment—say, a specific revenue growth rate or date to break even on cash flow—then more than 95% of start-ups fail.”

As you can see, entrepreneurs who invest in start-ups take on a huge risk so it is no wonder that banks are hesitant to lend out loans. Sarah Needleman gives a few pointers on how to prepare when applying for a loan: When applying for a bank loan, if you own a home, it will certainly increase your chances of getting a loan because it provides some sort of collateral. You also want to bring your resume and show what skills you have and how you are going to be successful in opening this business. When trying to secure a loan, you want to be prepared to explain how you are going to use the loan and what your strategy is for paying it back.