Competitive pricing and easier terms offered by U.S. banks on commercial and industrial (C&I) loans likely signal weakening asset quality for many commercial lenders, according to Fitch. Fitch expects some deterioration in C&I credit quality, particularly in a rising rate scenario, with smaller banks potentially facing greater risks as a result of their more recent entry into this loan space.
Tighter spreads across all asset categories have contributed to more competitive loan pricing by C&I lenders. Underwriting terms have also been loosened. With net interest margins compressed and yields on debt securities still very low, many banks have looked to C&I lending as a key growth driver.
C&I loan growth trends were strong in both 2011 and 2012, following a period of corporate retrenchment and debt reduction in 2009-2010 when new loan activity collapsed. According to FDIC data, total C&I loans provided by insured institutions grew by 12% in 2012, after increasing by 14% in 2011.
As Fitch noted in the March 2012 special report, "U.S. Banks' C&I Lending Trends," Fitch expects deterioration from the currently low levels of delinquent and noncurrent C&I loans and reversion to higher historical averages. Despite this reversion, we do not envision direct rating implications for most banks at this time.
The rating agency sees small and community banks as price-takers and term-takers in the current market environment, driving these institutions to build C&I loan books aggressively at a time when improvements in asset quality metrics are moderating. As a result, smaller banks are likely more vulnerable to a downturn in this space. That said, Fitch notes C&I loan growth has not been as robust at banks with assets of less than $1 billion, as loan demand from small businesses has not fully recovered yet.
Most U.S. banks continue to view C&I lending growth as a strategic priority as they look to diversify away from historically heavy dependence on real estate, particularly commercial property loans.
This portfolio shift away from well-understood real estate lending to C&I loans, and the risk of greater loan losses, has been noted as a bank supervisory concern by Fed officials in recent speeches. Fed governors raised the topic of rapid C&I loan growth, as well as weakening underwriting terms, in the April 30-May 1 FOMC meeting. In addition, the OCC noted in its most recent Semiannual Risk Perspective that extended periods of narrow spreads like those now observed in C&I loans usually reflect excessive risk-taking.
The Fed's April loan officer opinion survey indicated that a relatively large fraction of surveyed lenders reported increased competition and easier terms for C&I loans relative to the previous three months. About half of surveyed lenders noted that they had eased covenant terms for C&I borrowers in the previous period, up from 30% in the January survey.