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									                                              How Community Banks can Diversify Commercial Lending

Commercial Real Estate loans seemed like a sure bet for the banking industry for almost fifteen years.
“Dirt can’t hurt” was the school of thought, and there was no end in sight to the real estate market’s
ability to produce a profit. Until, the walls started tumbling down. The sub-prime mortgage crisis,
combined with the crumbling U.S. real estate market, has forced banks to rethink their strategies. Turns
out, dirt hurts and now it’s time to for banks to diversify their portfolios.

This white paper explores the feasibility for banks to diversify by increasing their volume of Commercial
and Industrial (C&I) loans. This paper also reviews the necessary resources for generating revenue from
C&I loans and highlights the benefits and challenges of different methods of handling C&I loans.

Commercial lending is essentially made up of two different types of loans; Commercial Real Estate loans
(CRE) and Commercial & Industrial loans (C&I). Over the past several decades there has been a shift in
the prevalence of each type of commercial loan. Prior to the late 1980s, C&I loans made up the largest
percentage of loan portfolios. In 1986, the majority percentage of portfolios shifted to CRE.

The shift to CRE made sense at the time. Commercial Real Estate loans provided the most effective way
for small to medium banks to make money. As the real estate market grew, the proportion of C&I loans
shrunk. It’s no surprise that banks were making fewer C&I loans—originating and monitoring CRE loans
is much less complicated and easier to calculate, and they don’t requiring such special training or
frequent monitoring. The low risk, high return real estate market provided excellent CRE opportunities
for the small to medium banks. CRE was a safer bet and they became the norm.

C&I Loans didn’t disappear completely. The larger banks continued to extend these loans to retail,
wholesale, industrial, and manufacturing companies. Large and growing businesses continued to rely on
C&I loans for working capital or to finance expansion through acquisition of property, plants and
equipment. As a result of the changing market, C&I loans became less common and were mainly the
domain of larger banks.

                                                             How Community Banks can Diversify Commercial Lending

This table shows the rates of Commercial Real Estate loans compared over decades to Commercial and
Industrial loans.

The Shifting Landscape of Commercial Lending
Over the past seven quarters, the landscape has changed significantly. Banks have experienced
significant losses due to real estate lending. Experts expect to see continued losses into 2009.1
As a result of real estate loan deterioration, banks of all sizes are evaluating current strategies and
making significant changes to focus on other asset types. In 2008, banks began positioning themselves to
increase their C&I loan portfolios, because these loans appear to be a more viable option in the current
economic environment.

  Izzo, Phil. “Economists See No Growth Until the Second Half of 2009.” Wall Street Journal. November 13, 2008.
  Based on data from the FDIC (

                                               How Community Banks can Diversify Commercial Lending

These charts show the average loan portfolio for community banks for 2008 compared to those
forecasted for 2011.

Expanding C&I Loans
More banks are considering increasing the number of C&I loans they offer. Our own research supports
this, with 96% of the 23 community banks we surveyed stating that they’re shifting their focus toward
growing their Commercial & Industrial Loan portfolio.

In addition to providing an attractive alternative to CRE, banks reported that C&I lending is more
profitable than other loan assets due to the low cost deposits that are derived from these relationships
and the ability to cross sell other products, specifically treasury management.

Community banks stand to benefit most by targeting small to medium sized businesses, because
historically regional banks have not effectively penetrated this market due to limited client relationships
and credit scored underwriting. Such businesses offer a valid way for community banks to break into C&I

A change in strategy is never easy. But banks that have little or no recent experience handling C&I loans
may be put off by the complexity. That’s why it’s important to understand the challenges.

Challenges for C&I Lending

                                              How Community Banks can Diversify Commercial Lending

The pursuit of C&I lending by community banks presents two significant obstacles. The first obstacle is
the ability to find employees who can effectively prospect and underwrite C&I transactions. The
widespread elimination of bank credit training programs has drastically reduced the number of
employees with C&I lending experience.

The second largest obstacle is the underwriting and monitoring of C&I credits. Small to mid tiered banks
don’t have the resources to staff the necessary credit and portfolio management that C&I loans require.
Only 21% of community banks surveyed have sufficient back office staff to manage working capital loans
or monitored lines of credit. Therefore, these banks must turn away these opportunities or refer them
to accounts receivable discounters or factors.

Given the opportunities that exist, how can small and medium sized banks break into the C&I market?

Smart Approaches to Increasing C&I Lending
Based on FTRANS research, the following recommendations may help community banks looking to
expand C&I in the current credit environment. First they must help their employees get the skills,
knowledge and systems they need to handle C&I loans. Secondly, they need to understand the different
ways to monitor credits and choose the one that best suits their institution.

    Talent Management: Retooling employees
    People can make the shift, but they need to:
         Gain the necessary training: Despite a decline in C&I lenders, the banker’s ability to
            effectively underwrite is paramount to expanding C&I lending. Many national and regional
            banks have separated the selling and the underwriting functions of a credit, but most
            community banks do not have the internal resources to divide them. As a competitive
            advantage, community bank Relationship Managers (RMs) should be trained on prospecting
            outside of Real Estate lending, underwriting, and managing loans. For banks not able to
            make the investment in internal training programs, state banking associations offer
            affordable training seminars and banking school programs.
         Understand the market and manage appropriately: Bankers need training to thoroughly
            understand their local markets. Community banks generally don’t have the resources
            available to obtain extensive research on business entities from data sources (such as First
            Research). This puts the community bank at a disadvantage. However, community bankers
            can compensate by being well educated on their geographical markets, industry trends and
            overall economic conditions that impact their customers and prospects.
         Develop a systematic sales approach: Community banks should develop a sales program
            that includes calling guidelines, tracking systems and processes for follow-up and closing the
            business. These measures will help insure that markets are appropriately prospected and

                                                        How Community Banks can Diversify Commercial Lending

         Credit Monitoring: Evaluate and Compare
         There are multiple ways to monitor credits. Community banks must evaluate their current
         resources and consider a method that fits their overall strategy.
              Asset Based Lending is a viable option for larger banks with a well trained staff. ABL
                 targets companies in growth mode with a minimum of $5MM to $10MM in sales. ABL
                 requires a large initial investment and a significant amount of labor, as credits must be
                 monitored on a very regular basis (as often as daily). ABL can be a profitable business for
                 banks. Keep in mind that it’s also risky, because one loss can cause a considerable
                 negative impact. (In sum: High risk, high return, highly labor intensive)
              Lite Monitoring is a viable option for most banks and is fairly easy to adopt. This method
                 targets companies that have been in business for at least three years and have a strong
                 personal guarantee. The bank takes a blanket lien on all assets, and the bank will only
                 require a monthly or quarterly borrowing base. Lite Monitoring can be an effective way
                 for a bank to make loans and it’s cost efficient for the client. However, it requires more
                 labor and the bank must have a strong understanding of C&I lending. (In sum, low risk,
                 moderate return, moderately labor intensive)
              FTRANS is a viable option for banks that want to expand their commercial client base
                 but don’t have a strong background in C&I lending. FTRANS can target companies that
                 need more observation than Lite Monitoring but are not candidates for traditional ABL.
                 FTRANS enables banks to accept accounts receivable (A/R) as collateral from a wide
                 variety of companies, providing small to medium banks with an opportunity to expand
                 their market base. It’s also cost efficient for clients and profitable for banks. Because the
                 monitoring and collections process is outsourced, FTRANS is an excellent program for
                 bankers who are not as versed in C&I or lack sufficient resources for ongoing
                 management. (In sum, low risk, moderate return, least labor intensive)

Following the collapse of the subprime mortgage market in 2007 and the struggling real estate market,
banks have begun to shift their strategy to include more C&I lending. According to research based on
our surveys from community banks, the two biggest obstacles to increasing C&I lending are shifting the
balance sheet and a lack of C&I lenders with credit experience. Banks can overcome these obstacles by
providing training, understanding the market, and considering alternate types of monitored loans.

To learn more, attend one of the FTRANS webinars. Information available at

** The research obtained in this report is based on interviews with financial institutions throughout the United States from
             th              th
November 14 to January 15 2009.

How Community Banks can Diversify Commercial Lending


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