Here's Why the Business Loan Boom May Be the Next Bust


As the news that mortgage lending is heading into slow mode sinks in, reports that commercial and industrial lending is on the upswing seems like a ray of sunshine. Relaxed lending standards are causing somewhat of a boom in this area -- which seems to bode well for both Federal Reserve policy as well as the overall economy. After all, quantitative easing is all about creating an environment that is hospitable to lending, and businesses that borrow usually use the money to expand and -- hopefully -- hire more workers.

But there is a dark side to this ramping up of C&I activity: risk. With competition for these loans at an all-time high, banks are stretching guidelines and dropping interest rates -- both possible harbingers of problems in the future as margins become squeezed further, and these low-rate loans become unsustainable once interest rates begin to climb.

More loans, less profit
While the move into the C&I sector has been going on for some time, it has been becoming more dicey as of late. A recent Fed survey of bank loan officers shows that 65% of banks have relaxed commercial lending standards, while reporting no such easing of their residential lending terms. In addition, 33% are including fewer clauses in these loans, which would protect the lender in cases of default.

The nation's biggest banks are jumping head-first into this market, with large regionals not far behind. Bank of America , for example, recently announced that it is bulking up its own C&I department in an effort to take on rivals JPMorgan Chase and Wells Fargo . Less than one month ago, the head of B of A's Baltimore, Md., market noted that pumping up business lending in that area is a top priority.

JPMorgan and Wells aren't holding back, either. The biggest U.S. bank just made a huge push into the Charlotte, NC market -- Bank of America's home base. The open house for its new C&I lending facility will commence this week, immediately following the bank's annual meeting. For its part, Wells saw its commercial lending increase by 12% last year, as it courts the business of entrepreneurs previously too skittish to make improvements in their facilities.

Large regional banks have been getting in on the act, too. KeyCorp, Huntington Bancshares , and Fifth Third Bancorp all boosted their commercial loan portfolios last year between 18% and 20%.

But, as a piece in The New York Times points out using Huntington Bancshares as an example, this boon isn't all it seems. As newer loans with much lower interest rates cram the C&I portfolios and defaults begin to show up, trouble can ensue. A bank seeing an average 4% yield on its stable of business loans today, like Huntington, may be looking at a dangerously low 1.64% a few years down the road.

While the Times notes that the analysis isn't foolproof, the Fed was concerned enough to release -- for the first time since 2001 -- new guidelines for banks dealing with these types of leveraged loans, rules that are scheduled to become effective this week.

Too little, too late?
Whether the new regulations have arrived in time to prevent a bust in the commercial sector similar to the one seen with home mortgages remains to be seen. Some banks, at least, are recognizing the risks and staying away. As M&T Bank vice chair Mike Pinto tells the Financial Times, "Every 10 years or so, banks make some horrible mistake, and it usually starts with easy money." Hopefully, this time, such a calamity will be avoided.

With big finance firms still trading at deep discounts to their historic norms, investors everywhere are wondering if this is the new normal, or whether finance stocks are a screaming buy today. The answer depends on the company, so to help figure out whether Huntington Bancshares is a buy today, I invite you to read our premium research report on the company. Click here now for instant access!

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Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Fifth Third Bancorp, Huntington Bancshares, JPMorgan Chase, KeyCorp, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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