The Economy Is Humming

Loan growth at banks is slowing, casting a cloud over what was supposed to have been a banner year for financial institutions following last November’s elections.

Growth in each of the four major lending categories measured by the FDIC fell. Notably, the growth rate for business lending, an important source of revenues for banks in recent years, plumbed its lowest level since the first quarter of 2011.

Even more surprising is that falling rates of loan growth are occurring as many signals point to a more buoyant U.S. economy. Unemployment continues to decline, gross domestic product growth came in at 3% in the third quarter and business investment is rising.

Tepid rates of loan growth along with continued low long-term interest rates have taken some of the sizzle out of bank stocks.

Financial shares were among the chief beneficiaries of last November’s election surprise, soaring on hopes of a tax-code overhaul, lighter regulation and stronger economic growth. With progress in these areas spotty during 2017, gains are more muted.

The KBW Nasdaq Bank Index, a measure of 24 of the largest commercial banks, is up about 8% since the start of the year, about half the rise of the S&P 500.

“There was such enthusiasm coming out of the election,” said Gerard Cuddy, CEO of Beneficial Bancorp Inc., a community lender in Philadelphia. “I think reality is setting in.”

The slowdown in lending growth raises questions about firms’ prospects for 2018, especially given that long-term interest rates haven’t moved much, even as short-term ones are climbing. The difference, or spread, between 10-year and two-year U.S. Treasury debt, a rough proxy for bank profitability, is around 0.6 percentage point, its lowest level in a decade.

If loans balances aren’t growing briskly and the interest-rate spread is narrow, it is far tougher for banks to increase net-interest income.

“The plane used to be flying at 30,000 feet, now it’s at 10,000,” said Christopher Marinac, director of research at investment-banking boutique FIG Partners. “There are many banks that are concerned about how much they can grow the loan book in 2018.”

At the biggest U.S. banks, loan growth in the third quarter was spotty. At J.P. Morgan Chase & Co. and Bank of America Corp., total loans grew 3% from a year earlier. Citigroup Inc. posted growth of 2%, while total loans at Wells Fargo & Co. fell 1%.

Loan growth was anemic among many smaller banks. At BB&T Corp., total loans in the third quarter were roughly flat compared with a year earlier. In an earnings call last month, CEO Kelly King said more clients were taking advantage of low rates in the bond markets and paying off their bank loans. Hurricanes in the southern U.S. also had an effect.

He added the bank is purposely restructuring its loan portfolio to focus on more-profitable loans. Still, Mr. King nodded at deeper issues around the downshift, saying “the mega issue here is that, you know, we’ve been on a nine-year slow economy.”

An area of particular concern for all banks is business lending. In the third quarter, the 12-month growth rate for business loans fell to 2.48% from 2.79% the prior quarter and 7.67% a year earlier.

The drop-off is even more pronounced based on weekly Federal Reserve data. Commercial and industrial loans, or business lending, in early November were up less than 1% from a year prior, the data show. From mid-2014 through mid-2016, growth of such loans was regularly in the double digits.

This is putting 2017 on track to be the worst year for business-loan growth since 2010, when the economy was still wrestling with the immediate aftermath of the financial crisis.

Why that is remains unclear. Throughout the year, some banks have said that more subdued business lending was due to a lack of clarity from Washington on the fate of key initiatives such as taxes and health care.

Such worries should eventually fade, though, said Darren King, finance chief at M&T Bank Corp., where loans in the third quarter were down 2% versus a year earlier. “Business owners are eventually going to get to the point where they say, ‘I can’t wait to find out what is going to happen in Washington,’ ” he said.

Even so, “that doesn’t mean I think we’re going back to 2015 or 2016 levels” of loan growth, Mr. King added.

Some bankers also have cited heightened competition. More business customers are tapping the bond market instead of bank loans to take advantage of low interest rates there, while insurance companies are offering to fund 30-year commercial mortgages and hedge funds are lending to riskier companies.

Others think the slowdown in business lending is a hangover from above-average growth in recent years. Many potential corporate clients are already loaded up on debt, said Kevin Barker, an analyst at Piper Jaffray & Co. That tamps down demand for loans. It also makes some banks wary of lending even more to these companies, Mr. Barker added.

Nonfinancial companies in the S&P 500 have a debt-to-adjusted earnings ratio of more than 150%, Mr. Barker calculates — meaning that, for every dollar of adjusted earnings, they have $1.50 in debt. That ratio was around 0.7 or 0.8 for much of the post-crisis period.

Link: http://www.foxbusiness.com/features/2017/11/26/economy-is-humming-but-businesses-arent-borrowing.html

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