The shift in business loans from banks to alternative lenders was well underway prior to the pandemic.
But now the migration is poised to reach an inflection point as nonbanks continue to take market share in commercial and industrial lending, long a bread-and-butter business for banks.
For the first time, the percentage of C&I loans held by nonbanks will by the end of the year be nearly equal to that held by banks, according to projections by Autonomous Research, which analyzed data from the Federal Reserve’s most recent Flow of Funds report.
Autonomous calculated that banks’ share of the commercial debt market will drop from 24% in 2020 to 23% in the fourth quarter, while nonbanks’ share will rise from 20% to 22%, and corporate bonds will hold the rest. Six years ago, banks held 26% of the market, and nonbanks had 16%.
The data shows that nonbanks are “big, established businesses” that are “here to stay” as competitors to banks, said Brian Foran, the Autonomous analyst who compiled the Fed data as part of a semi-regular report tracking loan trends at banks and nonbanks.
“Probably five years ago in our report, we would have said these guys … will blow up in the next recession,” Foran said. “But now we’re five years in, and they didn’t blow up in the next recession.”
The convergence in market share for C&I loans is not entirely unexpected. For decades, alternative lenders have battled banks for loans, said Sarah Jane Hughes, a professor at the Indiana University School of Law.
In recent years, nonbanks have been aggressively competing against banks for both commercial and consumer loans. The most visible evidence of their growing clout is in residential mortgages, where banks’ market share has been
Nonbank lenders include such names as Apollo Global Management, Ares Capital and Saratoga Investment, all of which are providing financing for middle market companies.
“We’re in a perhaps more robust phase of nonbank competition, but we’ve basically been in a space of nonbank competition taking over pieces of bank action for approximately 40 years,” Hughes told lawmakers last week while giving testimony during a House subcommittee hearing. “It’s not like it’s new. It’s just a little more robust.”
Lately, alternative lenders have become an increasingly viable option for companies that need to make acquisitions and fund expansions, primarily because they tend to make more accommodations on loan terms than banks. In many cases, nonbanks also offer looser underwriting standards, lower collateral requirements and greater speed and flexibility when it comes to structuring or restructuring business loans.
The speed factor has been particularly relevant in the past 18 months amid a “massive uptick” in acquisition financing, said Matthew Bjonerud, CEO of Cerebro Capital, an online lending marketplace. Because there is so much capital in the market and companies are getting higher valuations, businesses are anxious to complete deals now, which is leading some of them to seek out nonbank lenders that can potentially move faster than traditional banks, Bjonerud said.
“If you think about all of those factors — they have a lot more capital, there’s a lot more competition for acquisitions and they have far less bureaucracy and underwriting hurdles — to be able to get those loans out and therefore close faster … it’s making nonbank lenders very popular,” Bjonerud said.
As of Friday, C&I loans at banks were down 13% year over year, according to the Fed’s most recent weekly economic snapshot.
In certain cases, banks may be losing market share in C&I lending because of their own decisions. Some have pulled back on commercial lending, especially to small businesses, to pursue other opportunities that generate higher returns, such as corporate credit card relationships, said Kenneth Singleton, economist and professor emeritus at Stanford University.
The largest banks in the country are choosing to tie their corporate credit card businesses to other bundled products and services in order to generate more revenue, he said.
“They may be willingly letting this [C&I lending] business drift away,” Singleton said. “They have limited capital and the cost of capital has gone up since the financial crisis … so they’re going to naturally evolve in directions where … it’s more profitable to move in the direction of bundling products or building off deep expertise in certain lines.
So I don’t think this is, ‘Oh my gosh’ enormous bad news for banks.”
Treasury management services is another area that’s generally quite profitable for banks, Bjonerud said. If they can latch onto that business without making C&I loans, “that’s a huge deal” because treasury management is “so profitable and it’s sticky,” he said.
Meanwhile, some banks may be enabling their own market share losses by providing loans that allow nonbank lenders to exist, Foran noted in his report. In fact, lending to nonbank lenders and other financial entities has been the fastest growing bank lending category for years, according to Federal Reserve data that he analyzed.
From the end of 2014 to September of this year, bank loans to nonbanks and other financial entities climbed nearly 14%, Foran said. The category that grew second fastest was commercial real estate loans at just over 6%.
It would be hard for individual banks to walk away from the business of lending to nonbank lenders, Foran said.
“When everyone does it, it enables a whole category of competition that wouldn’t be there otherwise,” he said. “So they know it’s happening, but if they stop doing it, they will lose that business.”
To retain market share, some banks are going to have to “make bolder moves” — either striking partnerships with alternative lenders, including fintechs, or changing their standards to target middle-market customers in a more engaging way, said Aaron Byrne, the leader of financial services at EY Parthenon-Americas, a consulting division of Ernst & Young.
“They need to look at how they can be more agile and consider some bolder means of getting there now,” Byrne said.
Industry observers have different views on whether alternative lenders are on the verge of permanently surpassing banks in C&I lending. But one thing is clear: nonbanks are bigger and more formidable competitors on all lending fronts, Foran said.
“This is a reminder that when you’re a bank, competing against other banks is less than half the story,” he said.
