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Hamstrung by regulators in the consumer space, banks may once again find a sweet spot in commercial lending to midsize firms.
Vincent Ryan, CFO.com | US
October 15, 2010
Middle-market companies needing capital this year and next may not have to look much farther than a large regional bank. A combination of regulatory policy and banking-business factors will make expansion of middle-market commercial loan books an important part of restoring revenue and profit growth for commercial banks, says a report this week from CreditSights, a bond-market advisory firm.
The turnaround would reverse decades of decline of commercial and industrial (C&I) loans as a percentage of banks' total portfolios, points out CreditSights. That metric fell from a high of 40% in 1960 to 15% in 2010, thanks in large part to the massive buildup in consumer credit, which was aided by securitization. Now, with the passage of the Credit Card Accountability, Responsibility, and Disclosure Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act, "fat margins and high leverage have been largely legislated out of the [consumer] banking business," says CreditSights. Public policy is "leaning towards credit capacity for small and middle market businesses."
Overall, C&I loan assets at U.S. banks actually rose in July and August, after monthly declines of as much as 27% in 2009. "The consumer banking king is finally dead," says CreditSights.
With residential housing still depressed and net interest margins falling, banks are in a bind. The average yield on earnings assets for large U.S. commercial banks has fallen 102 basis points since the third quarter of 2008, to 4.8%. Needing to generate earnings assets that have attractive yields, banks will look to commercial lending, where they can get higher margins and terms, says CreditSights. Commercial loans also bring opportunities to cross-sell fee-based services.
If a true upturn in middle-market commercial lending gains steam, it will be good news for borrowers. According to the Federal Reserve's July survey of senior loan officers, banks have already eased standards and terms on many C&I loans as competition in the market heats up. Banks have also stopped cutting the size of existing credit lines, which are often part of commercial loan packages. Pricing on middle-market loans is ranging from LIBOR plus 150 basis points to LIBOR plus 350 basis points, depending on the company and industry. Maximum debt-to-EBITDA ratios are three times to four times, down from the peak of six times, CreditSights says.
Not all industries will benefit equally from banks' thirst for commercial assets. For instance, many banks are focusing just on health-care and technology companies for future loan growth, CreditSights says. Health-care and technology companies are projected to grow cash flow per share in the next 12 months by 22% and 14%, respectively, making them attractive borrowers — if they indeed need capital, says the advisory firm. Energy is another industry projected to outperform, although its financing needs will be weak in the next 3 to 12 months. In industries where the earnings outlook remains uncertain, however, such as building materials, banks will keep maturities tight and risk premiums healthy.
Among the banks positioning themselves to take a greater share of the middle market are Wells Fargo, U.S. Bancorp, and PNC Financial Services, according to CreditSights. Wells Fargo says it is expanding its middle-market efforts, particularly in mobile communications, software, clean technology, and technology services. U.S. Bancorp is looking to expand into metro markets where it can gain middle-market business from struggling or merging banks, and PNC is trying to capitalize on its high density of client relationships in Midwestern states with large manufacturing bases.
A resumption of business lending by banks — due largely to a betterment of their own capital positions — is a double-edged sword, however. "Banks are getting much more aggressive with smaller companies that are operationally as well as balance-sheet challenged," explains Varun Bedi, managing director and principal of Tenex Capital Management. "Banks are really taking a hammer to those companies that are bleeding cash and that have management teams they don't trust."
A significant rebound in commercial lending could also take some time, especially if the macro economy continues to have hiccups and banks get battered by other parts of their portfolios. "The question remains how material this middle market lending can be [for banks] and whether it can partly offset the residential mortgage market weakness that may hit the bank books once again with possible tsunami force," concludes CreditSights.