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Deep Dive | Alternative Lenders Grab More Market Share

Most bank executives weren’t making much of a fuss about alternative lenders in the middle-market lending business at the start of the year. Oh, how times have changed.

The non-bank lenders are accelerating their strategy to encroach on the traditional turf of banks, inching their way from commercial real estate to broader commercial and industrial (C&I) loans.

This trend is evident in numbers that should rattle bankers around the country. In the first six months of 2018, the dollar volume of alternative lending for C&I loans had already surpassed the $7 trillion total for 2017, according to data from the Federal Reserve. If these new entrants maintained that pace through the rest of the year, it means they will have increased lending by roughly $600 billion in 2018.

Banks, meanwhile, extended $2.3 trillion of C&I loans in 2017 and $2.2 trillion in the first half of 2018.

These trends highlight the fact that corporate customers are all too willing to give these non-traditional lenders their business. It also underscores that banks haven’t developed strategies to compete with these lenders for clients, opening the door for the alternative lenders to swoop in with favorable financing.

Indeed, the threats posed by these up-and-comers were a point of focus in third-quarter earnings and were a point of conversation during the conference calls of many large banks as C&I loan growth remained lackluster. Many large banks posted quarterly declines in C&I loan growth. Some saw no growth at all.

The incursion from alternative lenders is exacerbating tepid loan growth that is partly fueled by unexpected loan paydowns as corporate borrowers seek to avoid rising interest rates.

PNC CEO William Demchak called out a “shadow banking system” in the bank’s third-quarter earnings conference call.

“We don’t really play in the leveraged loan market, but that market being as open as it is has caused a number of our private middle-market companies that we historically have banked to go to private equity. While we might keep them as a transaction client, we don’t participate in the financing of that,” he said. “So that M&A wave is kind of pulling loan demand off and out of the banking system by levering it and putting it into CLOs and so forth.”

Participants of the Novantas Commercial Deposit Survey noted earlier this year that alternative lenders were encroaching into bank lending verticals, but there had been some hope that lending spurred by tax reform would offset some of that pain.

But most bank executives didn’t expect non-bank rivals to invade the traditional commercial middle-market lending relationship. Instead, most of their attention was focused on increased competition in commercial real estate where these lenders launched their initial attack.

By mid-2018, CRE loans at banks had grown 5.1% on a year-over-year basis, but that paled compared with the 7.5% increase posted by alternative lending sources. Bank management teams said they were unwilling to compete with the very aggressive terms — in both structure and pricing — that the alternative lenders were offering.

Non-bank lenders then became very vocal over the summer on the attractiveness of private debt as a growth opportunity, posing further risks to banks’ C&I loan and associated deposit-growth opportunities.

While banks were able to post solid second-quarter C&I loan growth of 6.4% on a year-over-year basis, alternative lenders pumped up their commercial growth by 6.6%, according to Z.1 data from the Federal Reserve. A majority of the increased exposure for alternative lenders came in the category of “other loans” that increased 18.6% year over year — an astounding figure relative to GDP growth.

The liquidity market is shifting as interest rates continue to increase domestically. Banks need to be cognizant of the risk that the growth in alternative lending brings indirectly to their balance sheets.

As more and more commercial credits are drawn away from core middle-market lending relationships, Novantas believes that banks need to address these issues on both sides of the balance sheet. This is especially the case as banks lose out on fees that historically have been tied to commercial banking and other associated activities. The banks also risk losing the treasury-management revenues and stable operational funding deposits that often accompany these commercial relationships.

What’s unclear, of course, is whether the incursion by these new players is a cyclical or secular development. In either case, there are certainly implications for the profitability of banking — whether in the intermediate term or the long term.

In the end, the answer may only be revealed in the next economic downturn.

Bob Warnock
VP of Industry Analysis, Chicago

For more information, contact Novantas Marketing

+1 (212) 953-4444

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