Are Narrowing C&I Loan Spreads Another Catalyst for Virtual Cards?

Navigator Edition: September 2015
By: Frank Martien

Since 2010, the average spread (i.e., interest revenue minus interest expense) for commercial & industrial (C&I) loans in the U.S. market has declined from 4.6% in 2010 to 3.3% in 2Q 2015 as shown in Figure 1. With lower returns ostensibly available from traditional C&I loans, where may banks turn for improved spreads and profitability?

Figure 1: U.S. C&I Loan Spread
for FIs1

Fig-1_-US-C&I-Loan-Spread-for-FIs1 For regulated depositories, company types = commercial banks and savings banks, reporting level = all companies, operating status = operating companies + acquired/defunct companies, and entity type = companies accessible through SNL. 2 Int Inc: Commercial and Industrial Loans / Avg Comm & Ind Loans. 3 Total Interest Expense / Avg Earning Assets.
Source: FDIC Call Report data accessed through SNL. Chart concept adapted from “C&I Loan Spreads Fall to 3.0%,” Analyst’s Journal, Barlow Research Associates, Inc., September 2, 2015.

So called virtual cards (a) are typically considered a transaction-based product that generates fee revenue for treasury / cash management organizations within commercial banks. However, when one considers requirements for underwriting and establishing credit lines for virtual cards along with funding transactions completed by clients with B2B merchants in anticipation of payment from clients on these balances, virtual cards may be considered a novel form of C&I loan. Furthering the notion of virtual cards as a form of C&I loan is frequent use for working capital purposes, such as cost of goods sold and inventory-related purchases.

By taking some liberties with how spread is calculated (b) in Figure 2, one can see that a comparable “spread” figure for virtual cards is estimated at over 18% versus 3.3% for C&I loans overall. Not only is this difference in spread enormous; but, First Annapolis estimates the 3.6% pre-tax return on assets for virtual cards to also be in excess of overall C&I loan spreads of 3.3%.

Figure 2: Virtual Card Economics
% of funded balances at 20x spend / balance

Fig-2_-Virtual-Card-Economics1 ~$80 billion in 2015 virtual card spend divided by a 20x ratio of spend to balances versus a total U.S. C&I loan market of $1.6 trillion. 2 Presuming 80% at a blended standard ticket rate of 2.3% and 20% at a blended large ticket rate of 1.4%. 3 Presuming 80% at a standard ticket rebate of 1.4% and 20% at a large ticket rebate of 0.45%. 4 Presuming a small contribution from late / delinquent payment and foreign exchange fees. 5 Network, processor, virtual card functionality provider, and virtual card program support costs. 6 At 3 basis points on spend.
Source: First Annapolis Consulting assumptions based on market observations.

While the above consider returns on balances, one should also consider balance levels in absolute terms for comparison. We estimate that virtual cards only comprise ~$4 billion or 0.25% of the $1.6 trillion in overall C&I loans – a very small portion. Consequently, most banks haven’t contemplated virtual cards as bona fide C&I loans in the context of spread or return on asset metrics. First Annapolis would observe, however, that best practitioner banks in virtual card issuance have likely achieved ratios of virtual card balances of up to 10% of C&I loans. Clearly, at this level, the favorable return dynamics of virtual cards can start to have balance sheet impacts on a bank.

Looking forward, virtual cards are projected to achieve 20 to 30% growth in spend over the next several years with similar growth in virtual card balance levels anticipated. For how long is this level of growth rate sustainable? With virtual card usage only comprising a few percentage points of B2B transactions while paper checks are over half of transactions, First Annapolis believes a relatively long runway for virtual cards is in sight and achievable.

(a) The term “virtual cards” is synonymous with vcards, virtual accounts, epayables, EAP, and other common terms for non-plastic purchasing cards accounts often integrated with accounts payable and/or ERP systems.
(b) Technically speaking, virtual cards have a negative spread since interest is not charged on these accounts; but, banks must still fund the loans.

For more information, please contact Frank Martien, Partner,, specializing in Commercial Payments and Bankcard Issuing.

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