What is Commercial Lending?

A commercial loan is usually given to a business to help with its capital requirements – to meet startup costs, payroll fulfillment, leasing corporate premises, and more.

It has a few key characteristics:

• Such loans require the business to post collateral such as cash, real-estate holdings, plant and equipment, or any asset that the lender can repossess if the business defaults.

• The business must also be deemed credit-worthy: it must usually submit documents demonstrating stable cash flows to establish that it can repay the lender based on the loan terms.

• Such loans also have more flexible credit structures than personal loans – in fact, some businesses can qualify for unsecured loans so long as the applicant signs a personal guarantee to pay it back if the business fails. Loans can even be unsecured by collateral, provided the applicant signs a personal guarantee to pay it back in case the business fails.

Types of Commercial Loans

Lines of Credit: Also known as a revolver, this is a loan where repayments rise and fall in tandem with the company’s working capital accounts.

Term Loans: A loan by which businesses can purchase assets whose value influences the loan terms.

Capital Leases: Like a term loan, a capital lease enables the borrower to acquire property or equipment, but it is the lender who owns the property lease.

Commercial Mortgages: A flexible type of commercial loan with which businesses can buy commercial real estate such as office space or industrial premises.

Small Business Administration Loan: An SBA loan is backed by the US Small Business Administration, thereby lowering the lender’s risk, and enabling them to lend to businesses that might otherwise fail to qualify. Both interest rates and repayment timelines are favorable, but the application process is lengthy and requires the customer to have a credit score of at least 680.

There are other loan types too . Businesses with high sales volumes can get merchant cash advances that they can repay with sales revenues. Businesses with unpaid invoices can get an advance from invoice factors who will collect on their unpaid bills. Equipment financiers fund everything from electronics for office space to industrial and farming machinery. In these cases, the equipment usually becomes the collateral.

The key virtue of a commercial loan is it gives businesses quick access to money – especially as regulations forbid them from raising funds from the bond or equity markets. Commercial lending has time and again helped the US thrive – it played a pivotal role in the economic booms of post-Civil War and post-World War II America – mainly by funneling the savings of citizens to entrepreneurs.

The Evolution of Commercial Lending

Commercial lending in the US has closely followed economic cycles. After the Revolutionary War, early banks lent to entrepreneurs , helping rebuild the economy. Post-Civil War commercial institutions funded infrastructure and industrial growth, sparking a second industrial revolution. The Great Depression marked the lowest point for commercial lending in the US, with loan volumes plummeting nearly 60% as the banking system collapsed . Recovery came with reforms like the Glass-Steagall Act , and the post-World War II boom, which revived lending. However, the Great Recession of 2008 saw a 16% drop in loan volumes, echoing past downturns. The most transformative change came with the digital age during the ’80s when online lending platforms disrupted traditional banking , and we will discuss both traditional and modern players in the industry in the following sections.

Commercial Lending - Key Players

Commercial lending in the US is populated by a variety of key players, each offering distinct advantages and services to businesses.

Traditional Banks: Traditional banks have historically funded US businesses large and small , offering term loans, lines of credit, and financing equipment. They have strict lending conditions and require excellent credit histories and valuable collateral. Their resources and reputations make them a safe choice for many businesses, though they are not as flexible as new players.

Credit unions: Credit unions are cooperatives that provide services much like traditional banks, but at looser rates. Their clientele usually includes the small and medium-sized businesses that are part of the communities in which they operate. Credit unions are smaller operations and do not have the lending capacities or the digital apparatus that younger business owners want.

Non-Bank Lenders: Neo banks, fintechs, and non-bank lenders are attracting businesses that won’t qualify under the stringent criteria of traditional banks by using technology not only to assess risk but also to streamline the loan approval process .
While these lenders provide quick access to capital and more flexible terms, they also charge higher interest rates because of the risks they assume. Marketplace lending essentially cuts out the middleman and has proven its mettle in competing effectively with the very institutions it seeks to bypass.

Government Programs: Government programs, such as the Small Business Administration (SBA), have long supported small businesses by lowering the risk that the lender has to assume. However such loans require one to undergo a strict screening process and have a strong credit history.
Other players include private equity and VC firms that lend to startups, insurance firms savings and loan associations that fund commercial real estate projects, and equipment financiers that enable customers to buy collateralized equipment.
We will discuss the commercial lending process, including key eligibility criteria, in the following section.

Local Economic Development: Community banks and credit unions are central to their local economies. Advanced credit decisioning models can improve their ability to extend credit to underserved segments of their communities, fostering local economic growth and enhancing financial inclusion

How Commercial Loans Work in the US

1. Commercial Loan Process

Commercial lending in the US involves several key steps:

Application and Documentation: Top Documents such as financial statements and business plans must show that the lender is capable of running a successful business and repaying the loan.

Credit Evaluation: A strong credit history and a steady revenue stream – if the business is already in operation – will help the lender assess the customer’s capacity to repay.

Collateral Assessment: Collateral is not only one of the main requirements for a loan, but the quality of collateral can help the customer get loans at much better terms.

Loan Underwriting: Lenders judge the risks involved in fixing the loan amount, the interest rate, and the repayment terms.

Approval and Disbursement: Once approved, the loan is disbursed, and the business begins repayment under the agreed-upon terms.

2. Key Eligibility Criteria

All lenders look for much the same things when deciding on giving out a loan. A history of regular payments and low debt increases your chances of approval. A steady flow of revenue means the business is in good financial health. Collateral is not only a minimum requirement, but in most cases, its value directly impacts loan terms.

3. Common Challenges in Securing Commercial Loans

Businesses usually face challenges in securing loans when the economy is in a slump – this puts them under pressure to demonstrate their financial stability . Rising interest rates just make borrowing more costly for everyone, affecting businesses as well. New businesses with a short credit history can find it hard to show they are credit-worthy and may be scrutinized further or simply rejected. And regulations, both federal and local, have now become a minefield for small businesses to navigate , and it is worth noting that commercial lending wasn’t even regulated at any level until recently.

The corporate finance institute states that commercial loans have far more complicated structures than other loan types, and this complexity extends to the screening of applicants as well, with credit analysis ultimately deciding whether a business secures a loan or not.

The Importance of Credit Analysis in Commercial Lending

Modern credit analysis essentially helps lenders decide whether an applicant gets a loan or not – it is the lynchpin of commercial lending and is computed using several metrics:

Credit scoring: The credit score essentially tells the lender just how risky it is to lend to a business. Models like FICO and VantageScore tell the lender the chance of the borrower defaulting, mainly by analyzing their financial conduct – and this is one of how the lender decides the interest rate.

Financial ratios: While the credit score looks into the borrowers’ financial history, financial ratios help scrutinize the company’s financial health . Ratios such as a company’s debt-to-equity ratio, interest coverage ratio, and current ratio help lenders determine whether the borrower will be able to repay.

The Role of Technology: AI and machine-learning models have taken credit analysis to the next level, allowing lenders to parse vast amounts of data and make faster credit assessments. Such technologies also reduce human error and bias in evaluating collateral and the borrower’s capacity to repay.

Credit analysis is the foundation on which a lender issues a loan – not only does it determine interest rates and repayment periods, but also protects both the borrower and the lender and helps stabilize the economy – from the earliest periods in free America’s history, sound lending practices have directly led to economic prosperity.

Commercial Lending in the US: Recent Trends

Recent trends show that commercial lending is growing despite coming under stricter regulatory scrutiny. While the pandemic affected all businesses, new businesses are being registered now that the world has returned to a new normal. Businesses today also want more personalized lending solutions , with flexible terms and an all-digital process – this is naturally compelling players to adopt technology just to cater to customer needs. New and sophisticated credit decisioning models have yielded stellar gains in both revenue and efficiency for those who have given them a shot, giving such players a competitive edge. Even regulatory pressures are now being confronted with technology known as ‘RegTech’ . But technology adoption appears haphazard – some lenders have adopted technology to provide a better experience, others have done so to improve credit decisioning, still, others have used it to plow through the regulatory thicket – there is a need for an end-to-end solution that employs all such technology to transform commercial lending.

Commercial Lending: Challenges and Opportunities

Commercial lending is projected to grow, but it is beset by challenges both on the technological and regulatory front, pushing players to adapt or be left behind:

Rising Interest Rates and Tightening Regulations:

Today’s high interest rates are making borrowing a costly proposition for any type of business , and even lenders are earmarking funds to cover future losses as interest rates rise. Newly-minted regulations at the state and federal levels – which do not fall under a single rubric like TILA – are further complicating matters for lenders – and banks are finally investing in ‘forward-looking analytics’ to better predict, and curtail, risk. The unpredictable economic environment and rising interest rates are straining borrowers and lenders alike. As such, every challenge is an opportunity to innovate, and the more complex this space becomes, the greater the need will be for a unified solution.

The Future of Commercial Lending in the US

Growth and Technology Adoption:

Commercial lending is poised to grow even as it is coming under stricter scrutiny. Experts predict it will grow at an annual rate of 13% over the next decade as interest rates across the world stabilize. In 2023, North America held the lion’s share – about 36% – of this market and will grow alongside the rest of the world, supported by growing demand as businesses return to the office. Commercial loan volumes could see a steady increase thanks to these factors.

Predictive analytics will soon speed up risk assessment, giving borrowers quicker access to capital. Additionally, the adoption of fintech solutions such as Finanta will streamline loan origination and underwriting processes , reducing operational costs and improving customer experience.

Potential Changes in the Regulatory Environment:

Recent regulations at both the federal and local levels do not fall under a unified framework – and if that wasn’t complicated enough, new regulations are expected to tighten lending practices in commercial real estate because of evolving risks in this market.

Players in this space don’t just have to prepare for tighter regulations, but new regulations that promote sustainable businesses or green lending – and this comes with its challenges. Lenders cannot just cut out ‘brown’ businesses and shift to the green lending space as it comes with its risks.

There is only one constant in commercial lending in the US: the need for advanced technology. As discussed above, America has historically thrived when businesses and entrepreneurs have had ready access to funding, and if regulations make technology adoption necessary to fuel business ambitions, then an end-to-end commercial lending platform is a necessity.

Conclusion

Whenever American lenders practiced sound lending policies, the nation didn’t just prosper, it boomed. Today, this market is a fragmented space with banks, credit unions, and non-bank lenders all offering a variety of terms – a far cry from the low-risk loans made out mainly by a small group of financiers to merchants and entrepreneurs during post-Civil War America.

No borrower is likely to tolerate a fragmented space where terms and policies change wherever they turn. Technology needs to unify this market if today’s lenders want to fuel the dreams of today’s businesses, just as those before did so.

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