Bank Lending Actually Increased... Sort Of

Here is an interesting article from the WSJ that helps to convey the complexities of the credit crisis:

(From the WSJ): "All around Washington, policy makers are scrambling to figure out how to get banks lending again. Lawmakers have criticized banks for not using new federal money to make loans and have threatened to place conditions on additional money. Regulators last week sent out a directive, encouraging banks not to hold back on lending.

But there's a flaw in that logic. Banks actually are lending at record levels. Their commercial and industrial loans, at $1.6 trillion in early November, were up 15% from a year earlier and grew at a 25% annual rate during the past three months, according to weekly Federal Reserve data. Home-equity loans, at $578 billion, were up 21% from a year ago and grew at a 48% annual rate in three months.

Graphic Courtesy of the WSJ

The numbers point to one of the great challenges of the crisis. The credit crunch is surely real, but it is complex and not easily managed. Banks are lending, but they're also under serious strain as they act as backstops to a larger problem -- the breakdown of securities markets.

The worst of the credit crisis is being felt not in banks but in financial markets. Loans from a bank might stay on its books. Increasingly in the past decade, loans were packaged into securities and sold to investors around the world -- pension funds, endowments, mutual funds, hedge funds and others. Institutional investors gobbled up this and other kinds of credit that didn't come via traditional commercial banks, such as junk bonds or commercial paper.

To get credit flowing, policy makers need to repair financial markets as well as banks. But investor confidence in credit markets has been shattered, in part because many debt securities performed so much worse than their credit ratings suggested they would.

Issuance of asset-backed securities -- instruments used to package credit-card and auto-loan debt during the boom -- was down 79% in the year through October from last year, to $142 billion, according to Dealogic data. In 2005 and 2006, investors snapped up more than a trillion dollars of these instruments. Junk-bond issuance was down 66% in the first 10 months of the year from the same period in 2007.

A new paper by Harvard Business School economists David Scharfstein and Victoria Ivashina sheds light on how the recent rise in bank lending plays into this. Bank loans are rising, the economists say, because companies -- from General Motors to Tribune -- have turned to banks for precautionary cash. With markets shut down, they're drawing on existing credit lines to meet financing needs or simply to have money in reserve in case they need it later."

While the data presented in this article does fly in the face of conventional wisdom, something to keep in mind is that the data points provided are measuring increased usage of credit lines granted during the boom, more than they are an increased willingness by the banks to lend overall. The best way to look at it is to consider a scenario where an individual (or business) has significant amounts of credit on existing credit lines available (even if they've been cut), despite the fact that they would have difficulty getting new credit . This would enable them to draw down existing credit lines and show up on the banks books as an increase in lending, even though this same individual (or business) wouldn't be able to get new credit.

I.e. this is more of a function of people using credit issued prior to the boom then it is a function of banks being more willing to issue new credit.  

Still on a go-forward basis this situation does present a variety of issues and risks for the banks to deal with, for instance:

Increased HELOC lending in an environment where home values are decreasing, thus reducing the likelihood that people can refinance their way out of trouble if they get overextended. This is especially true for homeowners who are currently in homes they wouldn't been able to buy without the lowered lending standards of the boom.

In all likelihood some of these consumers are drawing on HELOCs to pay their primary mortgage, and/or taking money from a HELOC and then turning right back around and using it make the HELOC payment.

The increase in HELOC lending suggests that many banks were vigilant enough with respect to cutting lines of credit, and/or monitoring the debt loads of their customers. It also means that there is a growing risk of an increased rate of future defaults in '09, which is especially troublesome when you consider the financial state of the banks at the moment.

Corporate Lending: in a similar situation to the above the companies that are leaning on their credit lines the most, are more likely to be struggling companies then they are companies that are simply using lines of credit in an environment where it's difficult to raise money via other means. This is not to say that financially healthy companies aren't using their lines of credit, just that struggling companies are much more likely to have to use what are usually emergency credit facilities.

Needless to say this also represents a major risk for the banks. 

Credit Markets: the fact that the banks are holding more loans on their books means that they're not only more exposed to the risk from these loans, but they've also lost a means by which they could raise cash. Holding on to risky assets and not be able to raise cash, is a double whammy that is going to (has already really) hit various institutions rather hard.

Overall the discussion of bank lending needs to be more holistic and connected to reality, as it has to consider the financial state of the banks, the difference between old and new credit lines and future risks. Furthermore we need to reset expectations around lending standards and ease of credit access, as I believe we're still comparing the present day to the credit boom (a time when standards were too lax) as opposed to thinking about today vs. the late 90s, 00-01.

Let's not forget that in the home mortgage market the overwhelming majority of the defaults are concentrated amongst the exotic loans (be they subprime or prime), while the default rate for fixed rate traditional mortgages (you know those old school mortgages that required down payments?) has barely budged.

Meaning that we should be more concerned about who the banks lend to and under what terms, than we should about lending volume in general.

You can read more here.

Sources

The WSJ: "Banks Keep Lending, but That isn't Easing the Crisis" -- Jon Hilsenrath, November 17, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.