After 5+ years of moving lower, the past two quarters have seen a marked increase in Commercial & Industrial Nonperforming Loans. Based upon numbers sourced from BankRegData, it is my opinion that Commercial & Industrial Loan performance has reversed and NPLs are heading much higher.
First, we're going to look at the startling increase in Commercial & Industrial NPLs the past two quarters.
Aggregate U.S. Banking Commercial & Industrial NPLs:
From a low of $8.515 Billion at the end of 2014 C&I NPLs have increased $2.381 Billion for a 27.97% increase in 6 months. The NPL % to total C&I loans has grown from 0.50% in 2014 Q4 to 0.61% in 2015 Q2. We'll come back to this ratio shortly.
Looking at C&I NPLs at the individual bank level reveals that the $2.381 Billion NPL $ increase is widespread and is not due to a small handful of institutions having issues.
Commercial & Industrial NPLs: Capital One
Capital One has seen C&I NPLs increase $233 Million (109.72%) over the prior quarter. Their NPL % has risen from 0.95% in 2015 Q1 to 1.99% in Q2. This appears to be a deterioration in their portfolio rather than an acquisition related increase. We also see an increase in their Early Stage Delinquencies as well.
Commercial & Industrial NPLs: Bank of America
From a low of $665 Million (0.31% of total C&I Loans) in 2014 Q4 Bank of America has seen NPLs increase $377 Million or 46.54% to $1.042 Billion (0.54% to total C&I Loans).
Commercial & Industrial NPLs: Wells Fargo
Wells Fargo saw the largest quarterly increase at $433 Million bringing the NPLs to $917 Million and 0.55% of C&I Loans (up from 0.27% in 2014 Q4).
As mentioned earlier, the C&I NPL increase is not isolated to just a handful of banks. Other banks who have seen notable increases the past few quarters include JPMorgan Chase, Comerica, Regions, Zions and Key Bank to name a few.
Why are Commercial & Industrial NPLs Increasing?
The Call Reports only break down C&I Lending & NPLs at the Bank level so it's difficult to look at sub-sectors and geography. Looking at the Community Bank sector I do not see that group struggling in North Dakota or Texas which would indicate Energy related stress although I suspect that is a part of the issue.
The biggest reason for the NPL increase in my opinion is that C&I lending has grown tremendously in the past 5 years and it is inevitable that delinquencies follow.
At $1.798 Trillion for 2015 Q2 Commercial & Industrial lending is just $9.94 Billion behind 1-4 Family 1st Liens ($1.808 Trillion) which has been the longstanding bank leader.
1-4 Family 1st Liens and C&I Loans Since 2004 (in trillions):
From the chart we can see that C&I and 1-4 1st Liens grew very quickly from 2004 through 2006, however, while 1-4 1st Liens plateaued at a peak just under $2 Trillion C&I continued to grow through the end of 2008.
From early 2009 through 2010 Q2, however, C&I fell very quickly shedding $345 Billion to $1.164 Trillion. At the end of 2010 there was a $569 Billion spread between 1-4 Family 1st Liens and C&I.
Since the low point in 2010 Q2 Commercial & Industrial loans have grown for 20 straight quarters.
Quarterly Net C&I Loan Growth (in billions):
2015 Q2 saw a $49.2 Billion increase over 2015 Q1. Only twice (2010 Q3 and 2013 Q1) was quarterly growth less than $12 Billion. Fourteen of the last 20 quarters saw growth in excess of $20 Billion QonQ. Over the last 20 quarters cumulative growth has exceeded $632 Billion.
Cumulative Quarterly C&I Growth Since 2010 Q3 (in billions):
The $632 Billion growth in 20 quarters is astonishing and we have only seen this level of growth happening twice before in history. The $1.006 Trillion dollar increase in 1-4 Family 1st Liens leading up to 2007 Q4 and the $588 Billion increase in C&I peaking in 2008 Q4.
While I'm not necessarily predicting the type of pain experienced during the post peak periods in 2007/8 I am suggesting that adding an additional net $632 Billion in C&I lending will lead to subsequent increases in C&I Nonperforming Loans.
There are two reasons for this stance: 1) Vintage Curves - huge lending expansions always have trailing increases in NPLs, and 2) C&I NPLs are starting from a bottom not seen in decades.
Commercial & Industrial NPL %:
The 0.61% in 2015 Q2 is up from the 0.50% low from 2014 Q4.
Note how the 0.50% is lower than the prior cycle low 0.62-0.63% range from mid-2007. Both the 2006-2007 and the recent multi-year drops in NPL % are exaggerated by the enormous increase in C&I loans which drives the NPL % lower. That said, the absolute C&I NPL dollar amount was dropping in both periods as well.
The prior NPL low in absolute dollars was $7.741 Billion in 2006 Q4 (at that point C&I loans were $1.218 Trillion). In 2014 Q4 the NPL figure was $8.515 Billion ($1.715 Trillion in C&I loans).
The following table details the 2 quarter change in NPL $ by loan portfolio.
Note how the C&I figure climbed $2.381 Billion (27.97%) in two quarters increasing to $10,897,602,000. This is in stark contrast to the continued declines in every other loan category save Farm related loans.
Part of the reason that most every other loan category is declining is that we are still experiencing elevated NPL % in most other loan categories. For example, Commercial Real Estate dropped 18.35% in absolute dollars, however, CRE's NPL% at 1.06% is still significantly higher than the prior low seen in 2006 Q2 at 0.58%.
With the exception of Credit Cards and C&I every other loan portfolio is still sitting higher than prior cycle NPL % lows.
Long time readers are aware of my prior concerns regarding the amazingly low yields that banks have on C&I portfolios. In September 2014 I commented on the aggregate 3.90% interest income ratio (yield) figure for the U.S. banking C&I portfolio. Since then, the rate has dropped another 21 basis points to just 3.69%.
C&I Yield for all US Banks:
In order for the aggregate to drop from the 450-500 basis point range in late 2011-early 2012 the incremental $632 Billion in new C&I loans are most likely below 300 basis points.
Some astute readers commented that if the Fed starts increasing interest rates then many of the C&I lending rates will also increase as per loan provisions. This is an excellent point, but what happens if interest rates don't increase yet C&I NPLs continue their reversal?
Let's take the flip and say all the businesses with C&I floating loans begin to experience rate increases. What happens to these firms' Income Statements as their C&I interest expenses accelerate?
Businesses have experienced enormous benefits with lower C&I rates. As banks begin to experience higher NPLs and Charge Offs then these benefits will begin to reverse and cause ripples through the economy.
Author's Note: This article is an updated version of the one first published on July 13, 2015 prior to the filing of 2015 Q2 Call Reports.