Bank Lending Growth Is Not All That It Seems

by: John M. Mason


Lending by commercial banks is up year-over-year. Business lending is also up.

A good portion of the lending is going to pay dividends, buy back stock, and acquire assets, not spur the economy along.

The "smaller" banks continue to hurt and continue to drop out of the banking system in large numbers.

Camilla Hall writes in the Financial Times, "US lending to businesses is reaching record levels but banks are privately warning that the activity should not be seen as evidence of an economic recovery."

Ms. Hall goes on that "much of the corporate lending is going to fund payouts to shareholders, finance acquisitions and fuel the domestic energy boom, bankers say, rather than support companies' organic growth."

This type of behavior is also hitting large regional banks: "The larger part of the usage in the market right now are loan refinancings where companies are paying dividends back out."

Furthermore, included in the business loan numbers is money going to hedge funds, private equity funds and real estate groups that have borrowed money to acquire real estate, bundle the properties and sell securities that use rental payments on the homes to provide the cash flow for the bonds. I have written several articles on this behavior.

The other active "commercial" lending area for commercial banks is in commercial real estate loans. However, this activity has primarily been located in the "smaller" domestically chartered banks in the United States.

These "smaller" domestically chartered banks, that is the rest of the domestically chartered banking system that are smaller than the largest twenty-five banks in the country, are the predominant holder of commercial real estate loans. On June 25, 2014, these "smaller" banks held almost two-thirds of all the commercial real estate loans on the books of the commercial banking system in the United States.

Over the past twelve months, of the approximately $110.0 billion increase in commercial real estate loans, more than $93.0 billion, or 84 percent of this increase, came in the "smaller" banks. And most of these loans were located in the larger members of the "smaller" banks.

Most of this increase in loans has gone to projects that were already started or had already been approved at an earlier stage. I have written about this situation many times over the past two to three years. In fact, these loans represented the real soft spot in the lending portfolios of these banks during the Great Recession and early recovery.

A very large number of these loans were five- or seven-year bullet loans where the bank received no payment until the loan came due. The big concern in the early years of the recovery was about how these loans would be worked out.

The answer to this is very clear. Many, if not most, of these loans were refinanced as the economic recovery progressed and as they were refinanced, additional funds were added to the loans in order to provide contractors the needed cash to see the project through.

Therefore, the large increases in commercial real estate loans have not gone to new economic projects but to the completion of projects that, one way or another, were already on the books.

In addition, the "smaller" domestically chartered commercial banks in the United States have become lenders for real estate and to consumers. It is hard to think of the vast majority of "Main Street" banks as lenders to finance ordinary business activity.

Almost two-thirds of the loans and leases made by the "smaller" domestically chartered commercial banks goes into real estate loans. Another 13 percent of the loans of these "smaller" institutions goes into consumer loans. Only about 19 percent of the loans of these banks go into what would be considered business loans.

This could lead to the conclusion that many of these "smaller" banks are nothing more than "thrift" institutions or something more like credit unions. In this sense, they are not really "commercial" banks in the sense of underwriting the regular business activities within their communities.

In fact, the largest twenty-five domestically chartered banks actually saw their portfolios of residential mortgages shrink over the past twelve months. The decline was over $65 billion. On the other hand, residential loans at the "smaller" banks rose by close to $50 billion.

And the "smaller" banks are not doing very well. Although bank closings are down, for the 12-month period ending March 31, 2014, the banking system had 219 fewer banks than it did a year earlier. There were 144 fewer commercial banks with less than $100 million in assets during this time and there were 101 fewer banks with assets between $100 million and $1 billion.

"Smaller" banks seem to be "out-of-style" and the regulators are just seeing that the reduction in the number of these smaller banks is done in an orderly fashion.

Certainly, the type of lending that is going on in the economy these days does not favor the "smaller" institutions.

Another "big" institution fact that needs to be reported is that foreign-related financial institutions continue to direct the liquidity created by the Federal Reserve's policy of quantitative easing "offshore." In the last four weeks, net deposits due to foreign offices have increased by slightly more than $37 billion to a total of $604 billion. It is hard to believe that before the financial disruption in the eurozone that this number was negative.

Over the past year, these foreign-related institutions have directed almost $240 billion to foreign offices.

These numbers are consistent with the fact that foreign-related institutions hold over $1.4 trillion in cash assets, almost 50 percent of the total of a little over $2.9 trillion assets in the whole US commercial banking system. Obviously, a lot of the largesse of the Federal Reserve System has flown to other places in the world.

Just a note, the reserve balances held by commercial banks at Federal Reserve banks totaled $2.6 billion on June 25, 2014. A lot of the excess reserves in the US banking system is held by foreign-related financial institutions.

Bottom line: the Federal Reserve's efforts at quantitative easing have not channeled a lot of money to the economy through the commercial banking system. The quantitative easing may have "saved" a lot of insolvent commercial banks that have gently been shown the exit door by means of acquisition. This, of course, is a very positive result. But, it does not contribute a great deal to stimulating the economy thorough bank loans. The commercial real estate lending is positive in that it has put a floor on this market for the time being. The hope is that the economy will continue to stay sufficiently robust so that these projects can finally reach completion. Then maybe more newer projects will come online.

The lending of the largest 25 banks primarily seems to be going to the larger organizations or to the projects of the wealthier segments of the country. Although this generates wealth, it does not seem to be located with people and organizations that are going to be spending wealth in a way that will add much more growth to the economy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.