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Top 5 Reasons You Should Avoid Banks

September 15, 2020

The remarkable resurgence in the U.S. debt markets since March has all but left banks out in the cold. Borrowers had raised nearly $2 trillion in the bond markets by the Labor Day weekend – almost twice as much as in all of 2019. Bank term loan volume, by contrast, was down by $31 billion year-over-year as of the end of August, according to S&P. Borrowers have some good reasons to avoid banks in the current environment. Here are the top five.

1. Price

Banks no longer have a monopoly on providing affordable debt to below-investment-grade borrowers and those with unusual or complicated credit profiles. In the past, these borrowers often found non-bank debt prohibitively expensive. However, since the Federal Reserve sparked a historic rally in March by promising to backstop the bond market, these types of borrowers have been able to issue debt at rates around 3%, and investment-grade borrowers have issued at 2% and less.

2. Terms

Bank term loans tend to be 5 years in maturity, putting borrowers at risk of not being able to refinance their debt if interest rates rise or if bank credit standards tighten significantly during that period. Non-bank financial instruments like bonds can be issued with longer maturities, reducing that risk.

3. Access

If companies in troubled industries like cruise line giant Carnival and airline Ryanair can issue massive amounts of bonds in this environment, anyone can. Banks, meanwhile, are reducing their lending. According to the Fed’s quarterly survey of senior bank lending officers, two-thirds of U.S. banks tightened lending standards in the second quarter, and one-third instituted their tightest standards in 15 years.

4. Flexibility

Bonds and other types of subordinated debt give borrowers more flexibility than bank loans, which are senior obligations, under the best of circumstances. Bond covenants – such as limits on further borrowings – are less restrictive than bank loan covenants. Banks had loosened their covenant requirements in recent years, but in response to the growing number of corporate bankruptcies in recent months, they are cracking down again.

5. Stability

Banks face a challenging future. Already, 17% of FHA-guaranteed subprime mortgages are in serious trouble. Corporate bankruptcies are multiplying. Banks’ favored method of offloading low-quality loans – bundling them into asset-back securities called collateralized loan obligations – is becoming more troublesome as investor demand for these securities wanes. The current phenomenon of negative real interest rates is bad for their retail banking and corporate cash management businesses. Banks are scrambling to change their business models to respond to these new developments – closing branches, shuttering money market funds, offloading non-core assets, and so on. Unfortunately, this means that borrowers cannot be sure that their business will remain a priority for their banks going forward.

Banks undoubtedly will remain an important source of financing and related services in the long run. But given the current attractiveness of other types of lenders and the uncertainty in the banking industry, it pays to carefully consider your alternatives.

Filed Under: Blog Tagged With: Business Loans, Financing, Lending, Private Lending, Real Estate Loans

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Carlsbad, CA 92009
760-671-3391

Providing Business Loans, Equipment Financing, and Working Capital

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