Commercial, Small Business Lending Steady Despite Crunch

MBA (4/18/2008 ) Palaparty, Vijay
The negative impact of the credit crisis on commercial and small business lending has revealed some decline, but fundamentals in these sectors appear controlled, remaining buoyant in an otherwise troubled economic environment, revealed a webinar from TowerGroup, Needham, Mass.
“The impact of the U.S. subprime market has created a ripple affect across the globe,” said Patricia Hines, senior analyst of whole banking at TowerGroup. “However, U.S. commercial banks are making good effort to keep themselves covered.”

Hines reported only a 3 percent change between 1986 and 2007 in the ratio of net loan and leases to total deposits at commercial banks. J.P. Morgan Chase, New York, stood out prominently with deposits significantly exceeding lending. Though net income and net charge-offs among commercial banks dramatically changed between 2006 and 2007, they were reported to be at historic levels—levels reached in 2002 when the internet bubble burst.

Commercial banks continued to lend between 2006 and 2007 despite a 13 percent increase in the number of loans outstanding. The last five years have seen a 37 percent increase in the number of loans outstanding. However, Hines reported record lows in terms of past due and nonaccruing commercial loans when gauged as a percentage of total loans between 2001 and 2007.

“The average across the six year period indicates an increase in past due and non accruing loan, but it’s only 1.8 percent of total outstanding,” Hines said. “In the current environment, banks will worry about that increase. However, outside of construction and land development sectors, the past dues aren’t as significant as they are on the consumer lending side.”

Despite the positive news, U.S. banks’ net interest margins are steadily declining. With increasing charge-offs, banks aren’t experiencing high rates of returns. U.S. banks overall experienced a decline from 4.3 percent in 2006 to 3.4 percent in 2007. Banks with assets exceeding $15 billion experienced a similar decline, falling to 3.2 percent in 2007 from 3.8 percent in 2006.

“The U.S. outlook sees a weakening of the U.S. dollar that has made U.S. products and services a good value for foreign firms,” Hines said. “U.S. exports were up 12.2 percent for the first 10 months of 2007. Businesses will face a tougher time refinancing existing short-term debt because of uncertainty over cash flows in a weakened economy. Additionally, financial institutions will experience increased usage of preexisting commercial lines of credit.”

Businesses using adjustable-rate credit products will benefit from continued reductions in the U.S. federal funds rate, Hines said. Also, middle market customers may not be affected by the credit crunch. She also forecasted that community banks and credit unions may not feel the credit crunch as they tend to rely more on relationship lending. “Banks will return to traditional underwriting, practicing the three Cs of credit: character, capacity and collateral,” she said.

Syndicated loans are disappearing, large loans made by the biggest lenders, Hines said. Last year was reported to be a good year for syndicated loans, but they are expected drop 26.8 percent in 2008. The U.S. fall will be the most significant, dropping from $2,282 billion in 2007 to an expected $1.372 billion in 2008.

“The largest deals are declining because there are no mergers or acquisitions,” Hines said. “We see a meltdown, but a lot the growth in this area is in Japan and Asia Pacific, both of which are expected to be up more than 50 percent. Today, banks are more focused on completing syndication of existing deals—credit overhang—rather than making new deals.”

In terms of commercial real estate, the Moody’s REAL Commercial Property Index cited in the webinar revealed industrial and office space sectors beating the national average. Though experiencing price declines, they are the best performing sector, Hines said.

Small business lending increased between 2006 and 2007—growing from $633.9 billion in 2006 to an estimated $687.5 billion in 2007. “It has been slow and steady but we see a decline because so many small businesses go out of business each year,” Hines said. "Entrepreneurs may find it most difficult with many using personal credit lines and home equity loans to back their business. Credit scores are important and there is no question credit now costs more for this segment."

Despite availability of credit, Hines also reported that business owners are holding back on spending because of recession and inflation fears. “Continued tightening and certainly more banks will look at consumer credit scores for small business owners,” she said, “Startups will have a harder time without collateral of real estate or equipment. Small business real estate lending is a bright spot with the emergence of work and live places. It’s a hard asset and there is collateral. Overall, however, small business owners are being hit with higher fuel prices and slowdown in the housing market.”

Hines predicts market instability will continue but suggests wholesale banking business leaders improve their ability to react to market fluctuation, and quickly. Market conditions have also pushed banks to think more about technology, implementing enterprise data management, portfolio management and risk management practices.

“It is especially important to gather information up front to understand the loan,” Hines said. “Increased use of business intelligence, data mining and predictive analytics will provide early warning of deterioration in loan and deposit balances or transaction volumes.”