COVID-19 is triggering the shift to a new economic reality across various industries and commercial lending is no exception. Although lending institutions and borrowers alike are struggling to come to terms with the norms of the economic volatility, the sector is returning to positive acceleration. Banks are evaluating the influx of loan applications from small ad mid-sized businesses and gauging risk in their existing portfolio. Commercial lending during COVID-19 is undergoing a digital transformation and innovation with streamlined credit underwriting and monitoring. Although uncertainty is looming in the post-pandemic commercial lending sector, a large number of financial institutions are adopting alternative channels to remain resilient.
How COVID-19 is shaping the trends in commercial lending
- Cautious approach
In response to the uncertainty cast over the economy by COVID-19, banks are being extremely cautious and conservative for new business and new customer production. The financial institutions shifted their focus to helping existing customers.
- Stringent standards
The financial institutions tightened their standards on commercial, industrial, and commercial real estate loans. Commercial real estate loans and industrial lending became the chief cause of concerns for top banks. However, CRE loans being the most vulnerable among commercial lending during the COVID-19 crisis.
- Re-assessment of credit risks
Commercial lenders effectively approved loans for businesses only after reassessing credit risk and proactively monitoring credit portfolios. While aiming to simplify the access to credits, banks and financial institutions were segmenting and identifying loans based on their future credit risk, forward-looking scenario and the best risk/return profiles. Lenders can follow these scenarios on a loan-by-loan basis, frequent re-analysis of risks, re-underwriting the loans etc. Moreover, they can implant advanced data and analytics tools. They can implement AI into credit portfolio management and due diligence for more accurate predictions and efficiency.
- PPP loans
In the wake of the pandemic, the federal government legislated the CARES Act and Payment Protection Programs (PPP) to protect borrowers. The PPP program established by the CARES Act aimed to provide small businesses with funds for up to 8 weeks of payroll costs including benefits. The businesses can use these funds to pay interest on mortgages, rent etc. PPP loans were administered through Small Business Administration (SBA) and issued by private financial institutions. These included community banks and large commercial lenders.
Banks were consumed with the charge of issuing the PPP loans in 2020. Banks started lending under the PPP on April 13, 2020. PPP activity stayed at the peak in the following months. However, the program closed on Aug. 8 with more than 5 million loans for a total of $525 billion lent. This was done through 5,460 participating institutions (banks, savings and loans, etc). The average loan size was $100,729.
New regulations in December 2020 expanded the PPP eligibility. Beginning March 1 2021, sole proprietors, independent contractors, self-employed and legal non-citizen business owners were allowed access to the program. Besides banks, lending institutions such as credit unions continued to issue new loans to local businesses. Further, these institutions also supported existing members and the stimulus programs. A report shows, a total of 4,077 banks—81% of all banks—were participating in the PPP program since the start of 2021, making 86.6% of loans and lending 93% of PPP dollars. However, since the initiation of the program, $596 billion has been approved for 6.04 million loans from 5,460 lenders.
- Commercial property loans
The lending scenario for commercial properties shifted mainly to purchasing and financing multifamily properties and industrial spaces. With the buoyancy trends in favour of such properties, individual investors leaned towards such commercial real estate assets for high returns. Hence, with low interest rates and historically low home mortgage rates, demand for commercial real estate loans continue to be on the rise. However, each transaction is carefully reviewed by investors and commercial lenders to determine the stability of the investment ad the asset’s performance.
- C&I loans
In March and April 2020, banks and other financial institutions in aggregate witnessed an exponential surge in the demand for business loans. As a result, the Commercial and Industrial (C&I) loans increased as compared to consumer loans.
C&I loans are secured and unsecured loans to business enterprises, including working capital advances and loans to start a business. Some business owners were even shifting to new ventures after selling their existing businesses. At the onset of the pandemic, many smaller firms borrowed to improve their cash buffers in the short-term funding markets. C&I loans across commercial banks increased to $539.91 billion or 23% from March 4 to April 15 with the major source of growth being businesses borrowing against existing lines. However, with the origination of PPP loans, C&I loans by larger banks declined. But smaller domestic banks saw C&I lending growth corresponding to a dramatic increase in the C&I loans. When PPP lending stopped by the third quarter, total C&I lending by larger banks continued to fall. In smaller banks, C&I lending levelled out.
- Digital transformation
The pandemic has created an urgency to shift from traditional banking and lending arrangements to digital models. To cope with the rising consumer demands, complex regulatory environment and growing cost of operations, financial institutions have begun refashioning their arrangements to digital infrastructure. In the highly erratic lending and borrowing climate, lenders globally will stiffen their underwriting and monitoring practices. This in turn will lead to improving credit decisions, borrower level monitoring, due diligence and measuring operational risks and flexibility. However, this entails crowdsourced aggregation of real-time data and its accurate evaluation. Therefore, more banks and lending institutions are turning to Artificial Intelligence (AI) for accurate predictive analytics and translation of unstructured data into more meaningful insights and automated credit scoring. Gartner reports, 75% of companies will shift from piloting to deploying AI-based technologies by 2024. As a result, they will see a 5x increase in streaming data and analytics infrastructure.
Moreover, the number of new-age Fintech players are growing with a reliant customer base in the Small and medium-sized (SME) businesses. In order to compete with them and capturing the SME demand, banks are adopting digital lending platforms. The need to deliver quality, frictionless client experience is driving the adoption of automation.
Further, combining automation to front-office operations will improve client experience. In addition to this, it will improve front-office efficiency, reduce costs and increase scalability.
Overall, banks encountered the pandemic crisis in good financial positions, with abundant liquidity and capital. Therefore, they expanded their commercial lending radius. However, Government-mandated stimulus and commercial real estate trends did play a major role in reshaping the standards of commercial lending during COVID-19. Banks were cautious with new lendings and it required significant shifts in the size and composition of bank loan portfolios and implementation of digital innovations. Thus it will be safe to say that financial institutions including both large and small banks played a crucial role in providing commercial credit during these demanding times.