A slowdown in bank lending is turning into ground zero for a debate over the growing gap between economic hope and reality in the wake of Donald Trump's U.S. election win.
The deceleration in loans made to companies and consumers has befuddled some analysts who worry that the worst growth rate in about six years bodes ill for the U.S. recovery at a time when expectations remain high. With credit acting as the lubricant for economic expansion, solving the mystery of the downturn has gained fresh urgency as investors wait to find out if the enthusiasm tied to Trump's pro-growth agenda will translate into a tangible boost.
“One of the stories for optimism at the start of the year was that the gain in confidence and financial market deregulation would spur a rebound in credit creation,” said Michelle Meyer, an economist at Bank of America Corp. “Surprisingly, the data show the opposite.”
Commercial bank credit rose by an annualized 4.2% in the week ending March 15, down from an almost 8% rate last year, according to analysis by JPMorgan Chase & Co.
Commercial and industrial loans have seen the biggest slowdown, rising by only $67 billion over the past 12 months, compared with $191 billion over the course of 2016 in a sharp reversal of a multi-year trend that has seen such lending surge to a record $2.1 trillion of outstanding loans.
Ask bank managers what the problem is and you'll get a lot of theories: Regulators have been eyeing underwriting standards in the wake of the lending boom, a shortage of qualified workers is preventing businesses from expanding, the rout in oil prices stymied demand, bank loans have been competing with a booming bond market, and of course, interest rates have been rising. But high up on the expansive list is the simple idea that it takes time for a more cheerful mood to materialize in actual activity.
“I would tell you that there is a huge amount of optimism out in the marketplace and I believe that it's going to be translating into a substantially higher loan growth as we head through the year,” said Kelly King, CEO of BB&T, in response to analyst queries.
The lending cooldown contrasts with surveys taking the pulse of the U.S. economy. Figures released Tuesday showed consumer confidence jumping to its highest level in more than 16 years, fueling questions over the growing gap between “hard” and “soft” economic data that has opened up since November.
“There have been a few troubling signs recently, particularly around loan growth that is consistent with this idea that business may be waiting for policy change and in the near term we could actually hit an air pocket in the U.S. economy where businesses are on the sidelines, and we get a period of slower growth,” said Paul Eitelman, strategist at Russell Investments, adding that executives need to see the Trump administration deliver on its policy promises before they can ramp up investment.
Corporate credit analysts at UBS Group share that concern, blaming a potent mix of political uncertainty, rising rates and historically high corporate borrowings for reduced demand for company loans. Companies have taken advantage of years of low interest rates and yield-hungry investors to load up on debt in a wide variety of forms.
“Anecdotes abound today that high leverage is altering real economic decisions. Companies today want to be sure that growth and tax policy will be tailwinds, before committing capital to work,” wrote analysts led by Stephen Caprio. “Simply put, the buffer for a miscalculation is not there for levered firms.”
Josh Rosner, bank analyst at Graham Fisher & Co., worries that the dip in lending may herald the long-awaited turn of the credit cycle after years of growth. He notes that more loans on bank balance sheets have been souring this year, which may spur banks to try to off-load nonperformers to specialist funds and investors.
“It appears that with rates low, banks have been able to refinance loans of weaker credits to support performance,” he wrote in a note published Wednesday. “Having scraped the bottom of the borrower-quality barrel it is likely that as rates rise, or liquidity is reduced, delinquencies and defaults will begin to rise as fewer credits will be able to be rolled.”
Others are far more sanguine. While slowdowns in bank lending do tend to coincide with recessions, there have been some instances of it softening in the midst of an economic expansion, according to economists led by Jan Hatzius at Goldman Sachs Group and Daniel Silver at JPMorgan.
The downturn in commercial and industrial bank loans is a “classic 'rear-view mirror' indicator of slowing economic conditions from late 2015 and early 2016, and as such doesn't provide any insights into future economic conditions,” said Chris Watling, chief strategist at Longview Economics, an independent research firm.
What's more, expectations of future credit conditions are bullish, presaging a likely uptick in corporate demand for loans in the coming months, according to Longview. Only a net 3% of U.S. businesses expect credit conditions to deteriorate, for example, according to a February survey from the National Federation for Independent Business. That's the strongest expression of confidence on credit conditions since 2004 — businesses are routinely negative on the credit outlook — and compares with a long-term average of 7.2%.
Whatever the cause of the slowdown, investors won't have to wait long to find out if it's a temporary blip or something more profound. A model by Bloomberg macro strategist Cameron Crise that smoothes changes in sentiment surveys suggests the drop in lending is reaching its nadir.
At Bank of America, Meyer sees a three-quarter lag between improving consumer confidence and credit growth based on historic correlations, which would mark early 2018 as the market's moment of truth.
“This means the potential improvement in the economy, as indicated by the strong surveys, is more a story for the next year than this year,” she said.
Bloomberg News
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