Changes in bank portfolios & worried examiners
Before the financial crisis, many financial institutions, particularly community banks, were overweight in Commercial Real Estate loans (CRE) loans, and these concentrations turned out to be particularly risky for many banks; some did not survive as a result of this, notes Michael Lubansky, a director of consulting services at Sageworks.
Commercial & industrial loans (C&I) as a percentage of total loans decreased following the recession when credit universally tightened, according to recent data from SNL Financial LC. But since 2010, C&I loans have become an increasingly larger segment of the average U.S. bank’s portfolio. From 2010 to 2011, C&I loans rose to 17 percent from 15 percent of total loans. There’s a similar trend in credit unions; since 2008, the average credit union business loan portfolio has increased to almost 6 percent of total loans from 4.6 percent.
With demand from the market and in response to the risk that was exposed among CRE portfolios during the financial crisis, it is becoming a common strategy for financial institutions to grow through the expansion of their commercial and industrial loan portfolio.
“For banks, a lot of them may or may not be as familiar with C&I loans, but it might be an area that is profitable for them,” noted Lubansky. “Some of them got into trouble with CRE, particularly Construction and Development loans. C&I loans present a profitable way to diversify their loan portfolio and reduce concentration risk.”
While this may seem like positive news for both the financial institutions and businesses that require capital to grow, regulators are showing some trepidation.
To help meet this C&I demand, financial institutions might be tempted to loosen credit terms so that they can remain competitive in the market. In a recent speech, Comptroller of the Currency Thomas J. Curry noted that examiners have seen financial institutions take on more risk in the search of profits.
“Right now, we see slippage in underwriting standards, especially with respect to leveraged lending and commercial and industrial loans,” the OCC chief said.
Regulators and bank examiners are concerned that financial institutions entering into or expanding their C&I portfolios will do so without ensuring they have the appropriate credit risk management processes in place. The concern is that the result could be inefficient covenants or analysis at origination, or improper monitoring as part of loan review.
“Infrastructure at these banks may not be set up to adequately measure the risk associated with these loans,” notes Lubansky. “The lack of adequate infrastructure and policies and procedures around C&I lending could leave financial institutions exposed, despite their intentions to reduce risk through diversification.”
“Examiners will focus on troublesome CRE since it was the big problem last time and because community banks had had such a focus on CRE. As concentrations of C&I lending increase, that focus might change slightly.” The increasing scrutiny could catch financial institutions unprepared.
To continue reading, download the whitepaper, “Shifting Credit Concentrations: 6 Ways to Prepare.”