C&I's Problems Go Well Beyond Energy Loans

The much-maligned energy sector is getting company on the most-wanted list.

Nonperforming commercial-and-industrial loans rose 150% to $23.6 billion in the first quarter from a year earlier, according to figures compiled by BankRegData.com. As a percentage of all C&I loans, nonperformers rose from 0.78% in the fourth quarter to 1.24% in the first quarter.

Because banks do not have to report a breakdown of nonperformers by borrower sector, it is easy to assume the blame lies with troubled industries like oil and gas that are grabbing headlines. But interviews with bankers and other experts suggest credit-quality problems extend to other kinds of clients, including construction subcontractors, farmers and taxi operators.

The existence of multiple problem areas is almost certain to lead to higher chargeoff rates in coming quarters.

"Plumbers, electricians — their profit margins are eroding," said David DePillo, president of First Foundation Bank in Irvine, Calif. "We appreciate the construction space and it's the lifeblood of the West Coast, but there are still a few laggards in the space that haven't recovered from the recession."

C&I loans are secured by inventories and accounts receivable, and those assets "tend to liquidate at pennies on the dollar," DePillo said. That will cause chargeoff levels to be higher than normal.

At the $2.7 billion-asset First Foundation, nonperforming C&I loans rose from $700,000 in the first quarter of 2015 to $4.95 million in this year's first quarter, representing about 3.1% of the bank's C&I loan book. The latest dollar figure was actually an improvement from the fourth quarter, when First Foundation's nonperforming C&I loans were $5.9 million.

First Foundation has no exposure to oil-and-gas companies, DePillo said. Its loans to construction subcontractors are classified as C&I loans, instead of construction loans, because the bank is providing accounts-receivable financing or working capital, and the loans are not tied to the underlying real estate, he said.

C&I weakness has surfaced in most geographic regions and at most big banks, said Bill Moreland, a partner at BankRegData.

To be sure, energy loans have been a prime mover of nonperforming C&I loans at some banks, and regulators have pressed lenders to downgrade energy loans and have changed how they review shared national credits.

At the $9 billion-asset Cadence Bank in Birmingham, Ala., nonperforming loans rose nearly fourfold to $207.6 million in the first quarter, compared with a year earlier. About 4.3% of Cadence's C&I loans were nonperforming in the quarter. The majority of nonperforming loans at Cadence are tied to energy loans, a bank spokeswoman said Monday.

Yet many of the banks that have demonstrated issues with C&I loans are not energy lenders, Moreland said.

Agriculture loans that are categorized as C&I loans have contributed to the uptick. The $11.8 billion-asset Old National Bancorp in Evansville, Ind., has downgraded asset-quality ratings for grain farmers, and the bank expects it will need to "restructure current lending arrangements to add real estate or government guarantees as credit enhancements," Daryl Moore, chief credit officer, said in a May 2 conference call.

Grain farmers "have had a couple of tough years and commodity prices are down, input prices have not dropped and weather has been an issue," Jim Sandgren, Old National's chief banking officer, said in an interview.

One problem is that regulators tend to pay attention to banks' real estate loan concentrations, to the neglect of other loan categories, DePillo said.

"The [Office of the Comptroller of the Currency] and other regulators have tended to focus myopically on real estate over the past several years," DePillo said. "Banks are under less scrutiny for their C&I loans, and that's allowed them to grow their portfolios without much oversight."

Bill Grassano, an OCC spokesman, declined to comment. In the OCC's semiannual risk perspective report for fall 2015, the regulator noted that underwriting standards have eased in C&I lending, although less so compared with indirect auto and leveraged lending.

One problem is that many banks have gotten deep into C&I loans that had little experience with making commercial loans, said Stephen Scouten, an analyst at Sandler O'Neill.

"You've got guys who were dirt lenders for 20 years and now they're doing C&I," Scouten said. "Everyone got pushed away from commercial real estate in the last crisis, but they just got pushed into a different asset class."

When commercial loans go bad, the potential losses are greater for banks because of what secures the loans, Scouten said.

"The severity of the losses on a default on a C&I loan could be theoretically higher, depending on the level of personal guarantees on the loans," he said. "If what you've got is inventory and machinery for an obsolete company, I don't know what that's worth."

Ultimately, the soaring rate of nonperforming commercial loans is due to the massive growth in the field, Moreland said.

"Banks have increased C&I loans by $750 billion in six years," Moreland said. "How is that not going to have credit problems?"