Part One of a Two-Part Series
For bankers lending out hefty sums of money, it is ideal to have collateral such as real estate. When the collateral is not as tangible, however, the risks are greater. Nevertheless, more banks are moving into the commercial and industrial loan sector, as well as commercial real estate lending. So many, in fact, that supply of capital seems to be outweighing the demand in some cases.

“Banks are looking to increase their bottom line,” said Jim Jones, president and founder of First Wellesley Consulting Group, a Wellesley-based management advisory firm that specializes in the financial services industry.

According to Jones, the increased number of competitors has created an imbalance between supply and demand in the commercial real estate lending arena. He said such loans are being priced more and more aggressively as the pool of lenders increases.

“The language bankers are using is that they literally need to steal business from other banks,” said Jones. “There is also a softening in that [commercial real estate] sector. There is a feeling that the market will continue to soften.”

However, Jones and other industry experts who follow local and national banking trends note that many financial institutions, especially smaller community banks and credit unions, are looking to break into or beef up their commercial lending presence in the marketplace.

With both residential and commercial real estate lending declining for many financial institutions, new avenues such as commercial and industrial lending are being explored.

“C&I is new to a number of mutual banks,” Jones said, adding, “I think this is a significant trend. I think we are really in the early stages. I don’t think it has peaked.”

Jones said larger financial institutions tend to shy away from the local businessman’s request for smaller loans, which in the past had created something of a vacuum. Community banks, he said, are filling that void. The smaller institutions are readily making lines of credit available to business owners and local developers, and changing the landscape of commercial banking in the process, he said.

At the end of July, the Federal Reserve Board issued Beige Book reports on its 12 districts, including Boston. According to the Fed, “commercial and industrial lending generally was at high levels and rose further in many districts.”

“It’s an evolution,” said David Falwell, executive vice president and chief lending officer of Natick-based Middlesex Savings Bank, of emergence of community banks in the commercial lending sector.

During the past 10 years, as numerous large banks have consolidated or left the local marketplace, the merger mania has been somewhat of an invitation to smaller institutions eyeing a role in the commercial banking sector, said Falwell. He said it was becoming increasingly clear that there was room for more players to expand into commercial banking. And now that the housing and mortgage markets are slowing dramatically, the move toward commercial banking by smaller institutions appears to again be picking up steam as banks seek to keep active in the lending arena.

“I think a lot of banks did put their toe in the water by getting into commercial real estate” lending in the past few years, he said.

However, Middlesex is not a newcomer to the practice, having first ventured into commercial banking two decades ago. But he said new entrants to the commercial lending arena have made even long-established players work harder.

“What you did 20 years ago doesn’t really matter,” he said. “We feel [competitive] pressure very much.”

The newest wave of movement in commercial banking seems to be drawing institutions specifically into the commercial and industrial lending business, often the next step following an initial foray into commercial real estate lending. Falwell joked that it is possible some of these bankers might not have known what C&I lending was 10 years ago, but today it’s an opportunity many are pursuing. The growing numbers of banks moving in that direction make landing opportunities more difficult, however.

“It’s [commercial lending] always been competitive. It still is,” he said. “More and more have gotten into it.”

Like Jones, Falwell touched on the issue of supply and demand with the scale tipped away from the bankers’ favor. Historically, Massachusetts has had a large number of financial institutions, increasing the competitive nature of the business, he said. Falwell adds that mergers and consolidation within the financial services community haven’t created any real sense of breathing room, and banks that only recently have begun actively pursuing commercial lending find they are entering a crowded field.

Incorporating Intangibles
Despite such barriers to entry, with the residential real estate market in a tailspin and mortgage volume down, banks are continually seeking new avenues to bring in money and attract customers, and commercial banking remains one of the most viable routes to do so.

There will always be people looking to grow or start a business, and such entrepreneurs are going to need lines of credit or loans to achieve success, said David E. Floreen, vice president of government affairs and trust services for the Massachusetts Bankers Association. Floreen said people in the banking industry are definitely talking about the increased attention commercial bank products are getting. However, the increased activity is not necessarily driven by new players in the field. Floreen said almost all banks do some form of commercial banking, and many are simply refocusing their efforts in that area in reaction to changes in the economy.

“If the market demands it [commercial loans], you go there,” he said. “More and more community banks are getting into that, or should I say increasing that. I think they all are [refocusing their efforts] because they are looking to generate more income.”

Bob Segal, chief executive officer of Danvers-based J. William Mantz Investment Advisors, said real estate-related commercial lending has been noticeably slowing for the past few months and he can understand why an increasing number of financial institutions want to now expand their commercial lending beyond real estate. However, he warns there are many more risks involved with C&I loans and that it is a much more complicated process.

Segal says banks are looking to diversify their businesses and reach out into a variety of new areas. He said commercial lending really needs to be conducted by people with expertise in that specific area because, when a commercial loan fails, it can be much more damaging to an institution, especially since collateral often is not part of the transaction. And nearly all banks that venture into C&I lending will see a loan or two go bad at some point. However, while such risks are magnified for smaller banks, Segal said being a small and locally based institution does have some advantages. The No. 1 rule in banking is “know your customer,” he said, and community banks have an edge in this department. A local bank may be able to offer a line of credit to a business borrower who looks a little more risky on paper because the loan officers and bank executives know the customer, the business and the local market. He said loan decisions need to be made carefully, but if the bank has deep roots in the community it may help with the decision-making process, since it allows decision-makers to see the bigger picture and more fully understand how the money will be used.

“The whole business of running a financial institution is about analyzing risk,” said Rob Kimmett, senior vice president of marketing for the Massachusetts Credit Union League.

“The local institution is going to be able to bring in the intangibles. They can blend character into the lending decision in a very careful way.”

Credit unions are among the institutions looking to increase their roles as commercial lenders. Kimmett said he does not believe credit unions are targeting a large portion of the commercial loan market, but they are increasingly exploring selective opportunities.

Part of the reason credit unions recently have started looking to increase commercial lending is that several have recently begun to adopt community or regional membership charters. Expanding from serving a specific business or industry group to a larger pool of potential members based on geography means such credit unions must reevaluate their offerings, he said.

Kimmett adds that commercial lending is not exactly new to credit unions. Historically, credit unions have worked to meet a variety of member needs, including business loans, he said. He said the loans have typically been on the smaller side, however.

“It’s something that some credit unions have done for a number of years,” he said.

But like community banks, credit unions are taking note that commercial lending is an area that seems to be not only in higher demand, but also gives the institution the ability to grow. Kimmett said the credit union industry is definitely playing a role in the trend that is seeing more financial institutions focus more heavily on commercial lending, and there are some local credit unions currently exploring how to enter the marketplace or strengthen that side of their business.

“Credit unions are seeing an increased demand for those types of services,” he said.