According to Fitch, competitive pricing and easier terms offered by U.S. banks on commercial and industrial (C&I) loans likely signal weakening asset quality for many commercial lenders. Fitch expects some deterioration in C&I credit quality, particularly in a rising rate scenario, with smaller banks potentially facing greater risks as a result of their more recent entry into this loan space.

Tighter spreads across all asset categories have contributed to more competitive loan pricing by C&I lenders. Underwriting terms have also been loosened. With net interest margins compressed and yields on debt securities still very low, many banks have looked to C&I lending as a key growth driver, Fitch said.

C&I loan growth trends were strong in both 2011 and 2012, following a period of corporate retrenchment and debt reduction in 2009-2010 when new loan activity collapsed. According to FDIC data, total C&I loans provided by insured institutions grew by 12% in 2012, after increasing by 14% in 2011, Fitch added.

As Fitch noted in the March 2012 special report, “U.S. Banks’ C&I Lending Trends,” it expects deterioration from the currently low levels of delinquent and noncurrent C&I loans and reversion to higher historical averages. Despite this reversion, we do not envision direct rating implications for most banks at this time.

Fitch sees small and community banks as price-takers and term-takers in the current market environment, driving these institutions to build C&I loan books aggressively at a time when improvements in asset quality metrics are moderating. As a result, smaller banks are likely more vulnerable to a downturn in this space. That said, Fitch noted C&I loan growth has not been as robust at banks with assets of less than $1 billion, as loan demand from small businesses has not fully recovered yet.

Most U.S. banks continue to view C&I lending growth as a strategic priority as they look to diversify away from historically heavy dependence on real estate, particularly commercial property loans, according to Fitch.

To read the full Fitch article click here.