C&I Lending with Joel Pruis Extended Cut // Cornerstone Hot Takes

Hey, GonzoBankers. Tony DeSanctis back to talk a little bit about C&I lending, a market that, up until a few hours ago, I didn’t realize was about $2.8 trillion.

I brought in the big guns here, Joel Pruis, who runs our commercial lending business here at Cornerstone. He just did another study that I think is interesting and worthwhile for you to take a look at.

Joel, a couple of things that we found, or you found, in the study. You took the population and broke them out by percentage of C&I loans, with the most in the top 20%, and then broke it out into other quintiles from there. What did you find unique in that top 20% in terms of the folks with the biggest C&I portfolios?

One of the things was, like you said, we broke it out based upon their percentage of loans in C&I, from highest to lowest. That top 20%, the average was about 25% of their loans were in C&I. Again, that excludes any of the owner-occupied or non-owner-occupied real estate, one-to-four-family, etc. It’s strictly things like lines of credit, term loans, equipment loans, etc.

That’s almost twice as much as a percentage of the portfolio as the next level, which was only about 12% of the total. Then, if you go to the lowest 20%, it’s about five times more than that lowest 20%.

But it all resulted in their overall performance: higher loan yields, higher ROA, higher ROE and a lower efficiency ratio than the rest of the group.

All things I think all of our clients are looking for. Is the mix a function of, it’s not the size of the loan, I wouldn’t think, right? Because I would think commercial real estate is bigger than C&I. It’s literally just more at-bats in the C&I space.

It is. So you’ve got to be looking at it from, we’re talking small business, so a one-man shop that’s got a small line of credit to, we’ll call Microsoft and some of the big guys out there. When it’s not related to real estate, has a business purpose, that’s talking about C&I lending.

What we’re seeing out there is that it’s getting ready to take off. When you look at the balances, you mentioned the $2.8 trillion that’s out there. Well, that’s after we’ve gone through that growth expansion that the Fed is trying to slow down as much as they can right now.

Every time that we go through any kind of a recession or slowdown, once we come out of it, C&I balances take off again, and it’s up to the next level that they’re going.

So we’re right at a point where we can be getting ready. If we want to make a substantial change, right now is the time to be looking at it and preparing for when the Fed finally takes its foot off the brakes and allows the economy to take off again.

Yeah. I mean, again, we’re looking for places to grow loans, and that’s not mortgage, that’s not commercial real estate right now. C&I has been trending upward. To your point, everybody’s struggled with loans, but C&I continues to hold up.

So whether it’s lines of credit or inventory loans, things like that, I would think all that stuff is good.

This gets us to the second discussion, which is the relationship you found between real estate and C&I lending in terms of the mix of the portfolio. It’s almost an inverse relationship, huh?

Right, right, right. And it’s the real difference between one-to-four-family residential versus C&I.

Those that had the strongest portfolios in the C&I space had the lowest percentage of their portfolio overall in one-to-four-family residential. But those banks that focused on one-to-four-family residential actually saw the smallest percentage of C&I.

So that lowest 20% that had the lowest percentage of C&I, those were the ones that had the highest percentage of their portfolio in one-to-four-family.

You’re either doing C&I or you’re doing one-to-four-family. It seems like you’re not doing both. So from an expertise perspective, and I imagine your market dictates this to some extent, but you kind of want to decide where you want to be in those spaces and pick your lane.

Right, exactly. And it’s challenging as well for those, once they get into the real estate and the one-to-four-family, C&I is kind of that obscure type of lending that they don’t really want to venture into for whatever reason.

They get heavy into the one-to-four-family residential. So when rates are low, it does really well. One-to-four-family actually performs pretty well. But right now, that segment’s not doing anything, and we’re seeing that in the performance.

Their efficiency ratios are going up, their ROAs are dropping, their yields are dropping as well, and they’re having a hard time maintaining net interest margin. That’s different for the C&I folks. They’re maintaining a steady course and actually doing really well, even through this economic slowdown that we’re trying to get through.

You brought up a good point. Do you think the ability to underwrite is the challenge? It’s really easy to underwrite a piece of property. You go to the assessed value, you add a premium for square footage and all the other sort of basic math. Whereas it’s kind of tough to do lines of credit and inventory. It’s a tougher loan, isn’t it?

It is. I mean, it sort of is. It’s just a different mindset because you don’t have that hard asset of the real estate. Real estate doesn’t move. It can deteriorate, but it doesn’t move. It’s always there.

Whereas accounts receivable is this, “I can’t touch it. I can’t see it, and it can disappear in an instant.” So I’ve got to do some heavier monitoring of those things, and I really have to understand the overall customer base of my customer that I’m lending against those receivables.

So it does take a different approach. But I think one of the biggest things is that management has gotten used to that commercial real estate and even the real estate pipeline of deals.

Every time somebody’s buying or selling a home, buying property or refinancing, there’s a constant feed of those deals. It might slow down from time to time, but there’s still that constant feed.

Whereas with C&I, you’re trying to displace an existing financial institution from the relationship they have with that business, and that takes a while. It’s more competitive, and you’ve got to be patient, wait for your competitor to stumble, and then you can jump in and take over or come to them with a better product or offering.

So longer sales cycle, tougher conversion, a bit of a closed loop in terms of total volume out there available, kind of thing?

Right, exactly. Although the loan growth from the Fed that we talked about, the $2.8 trillion, that growth rate is still encouraging. So I think there’s some growth there.

The last piece is, and I guess this is a function of some of these challenges, the net charge-offs and the cost of funds are a bit higher on these loans, but the returns you get, right?

I’m a credit card guy. I’ve been in credit cards my whole life, and trying to get the concept of risk-adjusted margin through to my leadership teams at many institutions is always a challenge.

But it seems like C&I is very similar to that, which is there are inherently losses, but you get paid a premium in interest for that. That’s where you maintain those margins, assuming you’re lending appropriately.

Exactly, exactly. The numbers actually came out where, we talked about the yield overall being higher, about 70 basis points higher than the rest of the pack that’s out there.

But it does diminish a bit when you start to take into consideration the cost of funds and the net charge-offs. Cost of funds is fairly competitive. That net charge-off is higher than the rest of the group.

But when you deduct the cost of funds and the net charge-offs, you’re still 45 basis points higher than the rest of the group. So the net effect is still a significant positive impact.

Yeah, absolutely. This is great, Joel. I’m getting a primer on C&I, and I think we’ve got some opportunities to help our clients be more successful in the space. So thanks again.