Functioning credit markets are imperative for any sort of economic recovery. Whether they're paying suppliers, refinancing, or buying big-ticket items, businesses (and consumers!) need credit.

While Cisco Systems (NASDAQ:CSCO) had no trouble tapping the debt market for a large borrowing in February, that's been more of an exception than a rule lately. Another large, non-financial company, Deere (NYSE:DE), needed federal backing for its December entrance into the credit markets. Certainly, the government's recently developed Term Asset-Backed Securities Loan Facility program, or TALF, is beginning to help companies such as JPMorgan Chase (NYSE:JPM) and General Electric (NYSE:GE) offer debt. However, we won't be out of the woods until companies are able to raise substantial capital in the private markets without Uncle Sam's backing.

As part of my exploration of the current outlook for local credit markets nationwide, I spoke with Greg Dufour, president and chief executive officer of Camden National (NASDAQ:CAC).

Camden National is a full-service community bank focused on small businesses and individuals, operating in 40 locations throughout 12 of Maine's counties. The bank also has a wealth management arm that manages more than $1 billion of assets for individual, institutional, and municipal clients.

Examining the Northeast
In the first two parts of this series, I spoke with BB&T (NYSE:BBT) CEO Kelly King and UMB Financial (NASDAQ:UMBF) CEO Mariner Kemper. King was cautiously upbeat about the markets BB&T serves; Kemper, however, says the credit markets UMB Financial serves remain soft. Kemper noted that until real estate values recover, lending will stay weakened.

Dufour says he's seeing signs of stabilization in Maine, boosted in part by a large uptick in the amount of refinancing activity. He says the second quarter will be the best indicator of improvement on the "retail" side of the economy. Dufour also said that fractured confidence from the commercial side has begun to recover, to the point where commercial borrowers feel the worst has passed.

What follows is an edited transcript of the interview.

Jennifer Schonberger: What are you observing in the markets you serve? Are you seeing signs of recovery?

Greg Dufour: While I wouldn't say we're seeing signs of economic recovery in our markets, I would say that we're seeing some stabilization. The first quarter of 2009 started off particularly challenging, driven by consumer fears, which resulted in lower spending levels.

In a market such as the state of Maine, we look for signs such as a leveling off and eventual improvement in unemployment levels, as well as a firming in the housing market. Both have shown some signs of stability but are fragile right now, to say the least.

Schonberger: How do your lending volumes now compare with before this crisis? More specifically, now vs. pre-August 2007, and now vs. the end of 2008?

Dufour: As an organization, we're very much aligned on creating a loan portfolio that provides an adequate risk/reward trade-off for our bank as well as our customers.

Dating back to 2007, we felt there wasn't a good a risk/reward trade-off. We saw that the market was getting overheated, as we were seeing signs of irrational loan pricing combined with a loosening of underwriting standards by both national and local competitors.

As a result, we purposefully decided not to follow that trend. We kept to our underwriting standards such that most of our loan portfolio, excluding our recent acquisition of Union Bankshares, has remained relatively level. I would say within reason that our loan portfolio has been about the same amount from 2007 until now. Again, that has really been a conscious decision on our part.

But more to your point on attitudes about lending, our appetite for lending was just as strong pre-crisis as it is now ... [that said,] we pulled back from some of the markets we weren't real happy with looking at the fundamentals.

Schonberger: Many pundits out there say banks aren't lending; but maybe part of it has to do with the whole deleveraging process -- perhaps the demand side of the equation is to blame, too. Could you shed some light on whether your current loan volumes are a result from your end, from the consumer or business side, or a combination of both?

Dufour: Let me start off by saying that we are in the business of lending, and [we] feel we're positioned to take advantage of the opportunities where national and some local banks have lately retrenched. We stuck to our guns on pricing and underwriting for several quarters, and [we] feel that has provided us with the ability to lend where others seem to be tightening.

The recent decline in residential mortgage rates has set off a refinance boom, which has kept us busy. Our activity, especially since the first of the year, has involved both large and small commercial customers looking to reassess their relationships. The upcoming spring house-buying season will shed some significant light on the attitude of the consumer.

Schonberger: What are you seeing on the consumer side? Are they paying down debt? How strong is demand for credit? How has consumer behavior changed in the last year?

Dufour: Demand for credit has softened. We've seen several individuals who have paid down their debt, adjusted their spending habits, and improved their savings rate.

Schonberger: Are you seeing improvement in demand for new mortgages?

Dufour: The vast majority of our mortgage business is refinance activity, with some signs of life on the purchase side. In our markets, it is still a little early to tell if the housing market will rebound; but in conversations with several individuals, I'm starting to hear people say that they are starting to see some attractive pricing.

I think that's a function of a decline in real estate values, combined with low rates -- and people are saying, "It's time to jump in." We're hoping that with competitive interest rates and attractive pricing, the housing market in Maine will begin to improve.

Schonberger: The same for the commercial side -- what are you seeing there? Are businesses lining up for credit, or are they simply saying, in light of the recession, "Why should I increase my fixed costs to expand in an uncertain environment?"

Dufour: I'm a firm believer in business cycles, and what I'm hearing from my customers confirms that thought. Business owners are reassessing their commercial relationships as some sources of loans have dried up for them, yet they are beginning to see some improvements in their business activity.

Customers want to know if they going to be in business with a lender who is going to be here for a long time. We didn't take TARP money, so we have the benefit of not going through that. We actually have customers coming to us, saying that they want to talk with a non-national bank that isn't getting written up in the headlines every day. They feel there's a better potential partnership than with their existing lenders. ...

The potential to refinance is fairly strong now. To a lesser extent, there are some commercial borrowers, depending on what business they're in, who are looking at some stability in the system as well as at the prices of getting things restructured or acquisition equipment combined with low interest rates and they're starting to feel that now is the time to move forward. So I would say on the refinancing side, it's pretty strong and we're seeing some signs from a borrower's perspective of net new financings happening, but not as strong as three or four years ago.

Schonberger: Would you say demand on the commercial side is stronger than last fall?

Dufour: Yes, it's better than last fall, because the rates are very attractive and have remained low for some time. Prices for things have come down as well, whether it's construction costs or land acquisition costs, and I think people just have more confidence now than they did in the fall.

There was a huge amount of fear in the fall. People didn't know if we had bottomed yet or not; anecdotally, people are saying we're at the bottom, maybe it will get a little bit worse but we're not going to drop off a cliff here, so let's think about moving forward.

Again, it depends on whom you talk to. I can talk to some customers who are still extremely cautious and maybe they're looking at the glass being half empty. And then there are others looking at that glass being half full -- whereas if you go back to last November, everyone thought the glass was empty.

Schonberger: When do you expect to see a return to more normalized lending?

Dufour: In many ways, I feel we're actually in a "normal" lending pattern, where good, solid business plans showing solid cash flows are the basis for underwriting a loan. The "abnormal" lending is when loan-to-values are excessive, cash flow and debt service targets are compromised, and little attention is paid to documentation.

The solid borrowers and solid financial institutions are probably those groups who are looking at today's environment with the feeling that we're getting back to the basics of business where good customers with good credit standings can find access to the funds they need. ...

I [also] think there will be a real change on the part of the borrowers, who are now approaching opportunities from a more pragmatic perspective.

Schonberger: Are you feeling more confident in the outlook for credit markets, now that government programs such as the TALF and the PPIP are in place? Do you think those programs will work in aiding lending or shoring up the banking sector?

Dufour: From a national and global perspective, credit markets have seen such a major disruption that it will take a significant amount of time and energy to get back to normal. While the TALF and PPIP will help, those efforts are, in my opinion, primarily addressing issues related to systemic risk in the financial system.

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Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. BB&T is a former Income Investor recommendation. The Motley Fool has a disclosure policy.