Shreya Jain, Nathan Johnson
Commercial and Industrial (C&I) lending has reached a new high with $2.35T in outstanding C&I loans to businesses as of Q2 2019.  In the past 5 years, outstanding C&I loan volumes have grown by a CAGR of 7%. The top 100 banks (by asset size) have followed a similar trend and have grown by 7.5% over the same period. This comes as no surprise amidst near-record low default and interest rates (Fig. 1).
Fig. 1 – ICE BofAML US Corporate 3-5 Year Effective Yield, Percent vs.
Delinquency Rate on C&I Loans (Source: FRED)
Within the banking industry, 60% of outstanding C&I loans are held by banks with more than $10B in assets, a trend which has remained consistent over the past 5 years. While the share of outstanding loans held by the top 4 banks – Wells Fargo, Bank of America, JPMC and Citi – hasn’t changed much, their growth rates have started showing a decline (Fig. 2).
Fig. 2 – Top 4 Banks’ Share of Total C&I vs. YOY Change in C&I Outstanding
(Source: Federal Reserve Statistical Release)
This might seem like a puzzling trend – why would the growth rate of the top banks in a healthy market show a decline? We may be observing the convergence of a few seemingly disparate trends, which could be explained in part using fish.
Contemplate the natural order within a lake inhabited mainly by large fish. They patrol the entire lake for available food, and if a smaller fish appears in their territory it quickly becomes a part of their diet.
Now let’s say after a while the big fish discover a new, plentiful food source localized in the warm shallows of the lake. They may start spending most of their time in this area and neglect the deeper areas where food is still available but has become harder to procure. This allows smaller fish to appear and eventually thrive in the deeper areas, making it difficult for the large fish to return should the need ever arise.
Now let’s use this lens to re-examine our lending scenario.
- It could be that big banks – our “big fish,” so to speak – are retreating from marginally profitable lending spaces but maintaining their market share by lending larger amounts to a smaller pool of clients. Their revenue is still growing, albeit at a lower rate, but they’re beginning to retreat from loans to smaller businesses.
- The data show this beginning in 2016, when average C&I loan sizes by the Top 4 Banks troughed at $84K (Fig. 3). Since then, the average loan size has grown by 13% to $95K per loan. This has coincided with a reduction in the growth rate of C&I outstandings by the Top 4 banks, from a 8% CAGR in 2010-2016 to a 6% CAGR in 2016-2018.
Fig. 3 – Top 4 Banks’ Total C&I Outstanding vs. Average Loan Size – 2010-2018
(Source: FDIC & FFEIC)
So who are the ones taking out loans, the “food source” for all the fish in the lake? While most large corporations can meet their financing needs from banks due to their strong credit history, audited financials, and ability to meet regulatory requirements, small and medium-sized businesses have historically presented an under-served segment of the lending industry.
John Birge, Chief Risk Officer at Credibly, remarked on another nuance of large banks’ involvement in the small business lending space. “The fixed costs of underwriting a small business loan for $100k is roughly the same as a $1M loan, but obviously profit is far less. Hence banks have never really wanted to play heavily in SME lending.”
It’s no secret that securing financing is a challenge for small businesses. Recent data from the Small Business Credit Survey (SBCS), an annual national survey run by the New York Fed on the financing needs of small businesses, provides deeper insight into this reality.
The survey finds that overall 69% of small businesses must still rely on their personal savings to meet financing needs. Among all small businesses—applicants and non-applicants— the SBCS finds that less than half (48%) indicated their funding needs are satisfied, 23% have shortfalls, and another 29% – including debt-averse and discouraged firms – may have unmet funding needs. When seeking loans, 86% of employer firms rely on their owners’ personal credit scores, a percentage that has been remarkably stable over time.
Given a choice between taking out loans from banks or online lenders, the decision criteria for small businesses show some similarities, but also some telling differences. If considering a bank, survey respondents cited (in order of decreasing importance)
- Having an existing relationship with large bank (58%),
- Chance of being funded (37%)
- Cost or Interest Rate (29%)
When considering online lenders, their top priorities became:
- Speed of decision/funding (63%)
- Chance of being funded (61%)
- No collateral required (45%)
In either instance, small businesses mentioned ‘long wait for credit decision or funding’ as their top challenge, followed by ‘difficult application process’ with large banks and ‘high interest rate’ with online lenders. Approval percentages for medium and high credit risk applicants were higher with online lenders than at banks, with actual approval rates of 76% to 34% respectively. 
All this reinforces the importance of watching a key development – the increasing market presence of alternative lenders.
This article was originally published on FischerJordan.com. Read more
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