Monday, August 19, 2013

Banks Water Down Loan Terms in Quest for Growth

By Tim Dulaney, PhD and Tim Husson, PhD

The Global Association of Risk Professionals (GARP) is reporting that banks are watering down terms of new loans under competitive pressure.  For example, some banks are increasing the length of amortization from the usual 15 years to the 25 years, others are decreasing required debt-service coverage from 1.25 to as low as 1 times cash flow while still others are waiving cancellation/prepayment fees.

The relaxation of loan standards is not unique to the commercial loan industry.  Recently, terms of residential mortgages and home loans have seen similar relaxation as home prices have been steadily increasing.  The Mortgage Credit Availability Index (MCAI) also indicates that loan terms have been weakening for the better part of eighteen months.

Of course by offering loans with more lax terms, lenders are exposing themselves to default risks and possibly helping to inflate another bubble.  However, lending standards are still rather tight compared to the heyday of the housing boom.  The MCAI, which is currently at a level of 112, would have been approximately 800 in 2007.

Nonetheless, it is interesting that lenders are competing on loan structure rather than on price.  It may be that banks fear the regulatory implications of over-leveraging, and thus are modifying loan terms as a way of gaining a competitive advantage without appearing overstretched.  Whether these modified loan terms will have repercussions in the senior loan or mortgage-backed securities markets remain to be seen.

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