Monday, November 30, 2009

Rising Commercial Loan Interest Rate Spreads -- Two Sides of the Coin

The US Federal Funds Rate continues to hover near zero, allowing banks to acquire funds for lending at historically low rates. But banks are spooked by record commercial loan delinquency and charge-off rates and have adjusted their interest rate spreads accordingly. The good news is that after a period of giving away commercial loans, lenders are being rewarded for the risks they take when lending money. The bad news is that commercial borrowers are facing the highest interest rate spreads since 2004. (Click on image to enlarge).

As seen in the accompanying graph, over the past two years interest rate spreads on commercial loans less than $1 million have increased approximately 30%. Throughout the early 2000s, as a result of intense competition from lenders, borrowers enjoyed narrow interest rate spreads on loans greater than $1 million. Those spreads have changed dramatically over the past two years, and spreads on large commercial loans increased almost 90%.

As discussed in my September 23rd blog post, rising interest rate spreads are a component of the continuing trend of tightening lending standards by US banks.

Tuesday, November 17, 2009

Commercial Lending by US, Canadian, and Euro Area Banks Continue Steady Decliine

Data from the Federal Reserve’s weekly sampling of 875 commercial banks for C&I and CRE outstanding balances shows continued steady decline in overall outstanding commercial loan balances. As shown in Slide 1, C&I and CRE balances have steadily declined every month in 2009, with an overall decline of 9.1% as of 11/04/09. Surprisingly, CRE loans have only declined about 5%, while C&I loans have declined almost 14%. (Double click on image to enlarge.)

Tightening credit conditions and the uncertain economic outlook in the United States continues to drive a decline in Canadian business lending. Looking at month-over-month data in Slide 2, business loans outstanding have declined 16.3%. Similar to the US, the decline in business mortgages is half that of the decline in non-mortgage loans (-7% vs. -17%).

The Euro Area’s slight decline in commercial loans outstanding continues. Overall loan demand is down due to a reduction in inventory investment and merger & acquisition activity. However, the month-over-month data in Slide 3 highlights a shift from shorter term loan maturities into longer term loans as a result of enterprises locking in long term funding at lower interest rates.

Wednesday, November 11, 2009

Business Bankruptcy Filings Continue to Rise in Lockstep with Unemployment

The United States business bankruptcy rate continues to be tightly correlated to the unemployment rate. As Exhibit 1 shows, business bankruptcy filings climbed an average of 12% per quarter from the 4th quarter of 2007 until mid-year 2009, compared to a 11% average quarterly increase for the unemployment rate over the same period. In the third quarter of 2009, the quarterly unemployment rate increase slowed considerably. (Click on slide to enlarge)

As the business bankruptcy rate is tightly correlated to the unemployment rate, expect a continued increase in bankruptcy filings until the unemployment rate improves.

Thursday, November 5, 2009

SBA Recovery Act Programs Finally Gathering Steam

On February 14, 2009, President Obama signed into law The American Recovery and Reinvestment Act of 2009 (Recovery Act). The Recovery Act contained a number of provisions intended to spur small business lending through SBA loan programs. After a slow start, there was a dramatic increase in new SBA loans granted under the 7(a) and 504 loan programs. A brief description of each of these programs follows:

Basic 7(a) Loan Guaranty: The 7(a) loan program is the most popular and flexible. Small businesses can use 7(a) loans for working capital, machinery and equipment, furniture and fixtures, land and building, leasehold improvements, and debt refinancing under certain conditions. Private commercial lenders provide 7(a) loans and determine whether to apply to the SBA for a guarantee during the loan underwriting process. The lender applies its own underwriting criteria when deciding to grant credit. In addition, the borrower and loan structure must also meet the SBA's eligibility requirements. Borrower requirements concern business size, eligible industries, use of proceeds, and availability of other funding sources. Loan requirements include amount, maturity, interest rate, percentage of guarantee, SBA fees, and prepayment penalties. As mentioned above, lenders often securitize the government-guaranteed portion of a 7(a) loan.

Certified Development Company (CDC), a 504 Loan Program: 504 loans provide long-term, fixed-rate financing to acquire real estate or machinery or equipment for expansion or modernization. Certified Development Companies (CDC) work with the SBA and private sector lenders to provide 504 loans to small business owners. A CDC is a nonprofit corporation set up to contribute to the economic development of its community. A 504 loan typically includes 50% financing from a private lender with a first lien position, 40% financing from a CDC funded by a 100% SBA-guaranteed debenture with a junior lien, and a contribution of at least 10% equity from the borrower. Because there is an active secondary market for 504 first lien position loans, banks can reduce their exposure on 504 loans to zero.

As shown in Exhibit 1, SBA Recovery Act lending was flat from June through August 2009. However, in September 7(a) loans increased 23% and 504 loans increased 81%. (Click on image to enlarge.)

It is not all that surprising that the 504 loan increase was triple that of the 7(a) loan increase. 7(a) loans are underwritten by private, commercial lenders looking focused on credit quality, loan covenant enforcement, risk-based pricing, and strong loan documentation. 504 loans are originated by nonprofit community organizations with the ability to securitize the 504 loans, reducing exposure on the loan to zero.