Joel Pruis
December 7, 2023
It’s time for banks and credit unions to finally execute those C&I lending priority initiatives.
Senior bank and credit union executives have ranked commercial and industrial (C&I) loans as a top lending priority over the past several years in Cornerstone Advisors’ annual What’s Going On in Banking research. But further analysis shows the execution is not measuring up. So, what’s the problem? Let’s explore the numbers, the challenges and tips for a winning strategy going forward.
A review of bank call report data from 2016 to 2022 for over 4,200 banks with assets of less than or equal to $70 billion reveals that:
- Only one out of every four banks was able to produce a measurable increase in the percentage of its C&I portfolio over the six years
- Only one in 10 banks that started in 2016 with C&I less than 18% of its total portfolio was able to grow the percentage above 18% in 2022
If C&I has consistently ranked so highly in the minds of lenders, why have we seen so little change? In a nutshell: real estate lending.
Most of the talk about commercial lending is currently focused on commercial real estate and market conditions for office properties. Certain characteristics of CRE and mortgage/refis make C&I lending an unfamiliar and potentially uncomfortable segment for banks and credit unions:
Sales Cycle – Unlike real estate, C&I lending doesn’t present a consistent flow of applications and opportunities. C&I relationships require a financial institution invest time into building new networks and be ready to displace the incumbent when the opportunity is presented.
Credit Risk Appetite – Changing from real estate lending with its tangible collateral and emphasis on loan-to-value, rent per square foot and debt service coverage to C&I lending with at least a portion of the collateral considered intangible (such as accounts receivable or, worse yet, enterprise value) and the emphasis on cash flows, fixed charge coverages and working capital cycles is a fundamental shift in credit risk evaluation and monitoring.
Treasury Management – To displace an incumbent financial institution, the full relationship must be converted, not just the loans. Account analysis, positive pay, ACH, wires and many other services are of equal importance when it comes to building the C&I portfolio. Without a strong treasury management offering, a bank or credit union will only have transactional opportunities (equipment purchase, for example) resulting in marginal improvement at best.
Digital Engagement – With C&I comes more frequent engagement/monitoring activities. Quarterly financial statements, monthly borrowing base certificates with A/R agings, frequent line of credit draws and paydowns are things not typically performed digitally when most of the portfolio is real estate. Cornerstone’s finding that an estimated 50% of banks and credit unions do not have a commercial platform to support this type of digital engagement only increases the complications to achieve the needed digital engagement.
Measuring the ROI of a C&I Loan Portfolio
With all of these challenges, is C&I worth it?
Our analysis of key performance numbers comparing the top 20% C&I banks to the rest of the banks from 2016 to the third quarter of 2023 reveals that only 10% of banks with the minimum 18% of their loan portfolio in C&I loans in 2016 were able to rise to the top 20% in 2023.
The top 20% had an average of 24.27% of loans in C&I, more than two times the middle 60% at 11.89% and almost five times that of the bottom 20%, which had only 5.55% in C&I.
Those in the top quintile outperformed the other 80% as it relates to:
- Loan yield (all loans): 4 (68 bps higher)
- Net yield (after cost of funds and net charge-offs): 0 (56 bps higher)
- Efficiency ratio: 3.43 (7.86% lower)
- Return on average assets: 4 (35 bps higher)
- Return on average equity: 1.31 (4.89% higher)
Looking at the above performance differences (plus many others noted in the full analysis), I have a hard time seeing the disadvantages of a strong C&I portfolio.
Launching a C&I Lending Strategy
So the big question is, when should a bank or credit union start the initiative to grow its C&I portfolio?
The answer is, RIGHT NOW!
Trends in total commercial and industrial loans from 1990 to 2022 reveal significant growth in C&I following an economic slowdown or recession. It seems obvious that when the economy shrinks, so would C&I loans, and when it is growing, so does C&I lending.
With the Fed completely focused on bringing down inflation with increased interest rates and the intent to create some type of recession or reduction in GDP, we know that afterward, the focus will shift back to economic growth, and that means growth in C&I loans. One sign that we may be at the start of the slowdown is that C&I loan balances have declined in each of the past two calendar quarters.
Should banks and credit unions just wait for the economy to go through the slowdown/recession and when growth returns start to pursue C&I? No. Those that wait for the rebound are already behind the competition.
There is minimal downside risk to start prepping now for the rebound to take full advantage of the future growth opportunity. We recommend incorporating these activities in your 2024 C&I lending strategy:
- Follow up with recipients of PPP loans granted in 2020 to potentially expand those relationships
- Evaluate and fill any gaps in the current product offering for both loans and treasury management
- Inventory all available talent, tools and technology that will be needed to properly evaluate and monitor the credit risk of a larger C&I loan production and portfolio
- Review current segmentation strategies to avoid the trap of “one size fits all” as it relates to loan origination and portfolio management
- Familiarize/educate senior management on the differences between traditional CRE lending and C&I lending
- Establish connections into networks more likely to be associated with C&I opportunities
Through it all, maintain patience and persistence. C&I is playing the long game, and early quick wins will be few and far between. But that said, C&I lending is worthy of being a high priority at any financial institution. The performance benefits are evident, and the future growth opportunity looks to be on the horizon. So, lenders, PUMP IT UP!
