Wednesday, April 11, 2012

Why Do We Have Slow Loan Growth?

Consider the following quote from Fed President Lockhart's Speech, explaining why low interest rates are not leading to a boom in lending.

Here are some factors that have restrained the demand for bank credit.

Larger businesses are flush with cash as a result of strong cash flow generation. Corporations have aggressively controlled costs and exploited productivity gains. All this has added up to relatively weak commercial and industrial loan demand.

Smaller businesses haven't yet seen much revenue growth and remain cautious about borrowing given their perceived growth prospects. In addition, collateral values supporting small business borrowing haven't recovered, in many cases.

Households continue the process of deleveraging, and, as a consequence, consumer loan demand, broadly defined, has been soft. While there have been pockets of growth like auto loans, most categories have been pretty feeble. There are a number of reasons, including fear of job loss, lack of income growth to cover debt service, lost home equity value, repair of personal balance sheets, and impaired credit scores.

And as for the supply of bank credit, here are some factors that you bankers have been living.
  • Underwriting standards across all loan categories have been tightened as a result of the financial crisis and recession.
  • Some banks are capital-constrained and cannot grow their balance sheets even if there were stronger loan demand.
  • Many banks are reducing sector concentrations, most prominently commercial real estate. The mix of loan portfolios is being reconstituted.
  • And there is the factor of regulatory supervision. I understand there can be different perspectives on this one, but no one would argue with the view that lending to creditworthy borrowers is good for the borrowers, good for the economy, and good for banks. In some cases, the combination of intensified supervision and bank management's need to improve regulatory ratings has put the focus on dealing with problems and suppressed appetites for aggressive loan growth.
Now, consider the above in reference to this chart:

 The above chart shows the percentage of commercial and industrial loans (C and I; the lower, blue line) and real estate (the upper red line) as a percentage of total assets.  Now, I put this chart together from the FDIC's quarterly banking profile spreadsheet, so there is a visual bug: YOU HAVE TO READ THE DATA FROM RIGHT TO LEFT.  This means the most recent data is on the far left side of the chart (sorry, but that's the way the data is organized).

Now, the data goes back to 1984, so we get a decent slice of information.  Over that time, notice the blue line is decreasing, meaning the percentage of C and I loans to total assets has been decreasing over the same period.  In 1984, the number was around 15% and the current number is around 10%.  While 5% might not seem like alot, consider that total assets for the chart are $13.8 trillion, so 5% is a fair amount of money (roughly $690 billion).

Let's combine the above information with the following two data points from the speech:

1.) Large businesses aren't borrowing because they already have more than enough case to fund operations internally.

2.) Small businesses aren't borrowing money because of economic uncertainty

If banks are trying to trying to "re-balance" their loan portfolios, meaning fewer real estate loans and more C and I loans, they are running into a really big problem: very low demand.  Hence, the overall economic environment is making it extremely difficult for banks to change their loan portfolios, leading to very low lending growth.