For all the concern about bank lending for office buildings, relatively few observers are worried about the mounting burden on corporate borrowers.
While stress is nowhere near the levels of the Great Recession, it is building rapidly as companies struggle to keep up with rising inflation and interest rates. Corporate bankruptcies are on the rise, suggesting banks may have to absorb more losses by lending to shuttered businesses.
Unlike commercial real estate, where banks can at least take over distressed office buildings, the collateral backing their business loans is typically weaker, meaning they are more likely to take a bigger hit if borrowers close their businesses.
Banking analysts aren't too worried about the current deterioration in commercial and industrial loans because banks generally don't have a high concentration in those types of loans, but they warn that investors should look more closely because business loan losses reduce banks' margins to absorb whatever pain comes to CRE.
“I'm always surprised by things I didn't expect or see,” said Brandon King, an analyst at Truist Securities. “I think C&I should be getting more attention these days.”
Banks charged off about 0.43% of C&I loans in the first quarter, a far cry from the 2%-plus rates seen during the last two recessions, according to Federal Reserve data, but the charge-off rate jumped from a pre-pandemic low of 0.12% to above the pre-pandemic average.
Banks also report that so-called problem loans are starting to rise, with more corporate borrowers struggling to repay their loans.
“Thankfully, it's not as bad as 2009-2010, but we're coming off the bottom,” said Chris Marinak, an analyst at Janney Montgomery Scott & Co. He said the issue “seems to be overlooked” compared with investor concerns about CRE.
Bankers have said in recent weeks that while some weaker borrowers and sectors have experienced some difficulties, their commercial loan portfolios remain broadly healthy.
The trucking industry stands out as it continues a steep decline that began after the pandemic ended the commodities boom. Borrowers in the senior housing and health care sectors are also struggling, with bankers blaming rising interest rates and labor costs.
Despite those weaknesses, PNC Financial Services Group Inc. doesn't have a “large group of borrowers” that should cause alarm, Chief Financial Officer Robert Reilly said at a recent conference.
“Things are looking pretty good,” Riley said.
Bankers, to the extent they are aware of the problem, are describing it as temporary.
Cincinnati-based Fifth Third Bancorp has written off loans to several clients whose business models have been challenged by the coronavirus, Chief Financial Officer Brian Preston said.
Barclays analyst Jason Goldberg noted at a recent conference that Buffalo, New York-based M&T Bank has seen losses on commercial and industrial loans rise for two consecutive quarters, contrasting with improving trends in the bank's commercial real estate lending.
M&T Chief Financial Officer Darryl Bible said lending to manufacturers and boat dealers drove the increase last quarter. The latter borrowers were hit by a slowdown in the sector, which had invested heavily in boating and powersports as consumers looked to spend more time outdoors during the COVID-19 pandemic. As buying slowed in 2022, many dealers “found themselves sitting on inventory,” Bible said.
Bible said M&T's charge-offs will be “uneven” over the next few quarters as certain customers have problems, but added that the bank could recoup some by liquidating borrowers' collateral or finding ways to repay them.
“It will ebb and flow,” he said.
Banks have been releasing a ton of disclosures about their real estate portfolios in recent quarters as part of an effort to counter the misconception among investors that all office buildings are uniformly bad assets.
As some employers transition to hybrid work, banks are creating slideshows that break down the types of buildings borrowers own, the states they're in, whether they're in urban or suburban areas, the level of amenities within the building and vacancy trends.
But such disclosures are much less common when it comes to C&I loans, said Truist analyst King.
“While we do not intend to downplay CRE concerns, we believe that emerging overlooked risks like C&I could surprise investors given the historical volatility of losses,” King wrote in a research note this month, adding that “a more severe default cycle remains a risk.”
King and other analysts say small businesses appear to be experiencing more stress than larger companies.
Credit reporting firm Equifax found in a report on Main Street businesses that delinquencies on loans, bills and other payments have spiked, but delinquency rates are still below pandemic-era highs and well below levels seen since 2008, according to Equifax CEO Sal Hasday.
“This is a small delinquency compared to the mountain of delinquencies that occurred in 2009 and 2010,” Hasday said, noting that small businesses remain resilient despite declining levels of consumer spending.