Commercial Bank Lending: Like Pre-2008?

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by: John M. Mason
Summary

Concern has been raised about a possible debt-crisis in the future and the role that commercial banks might play in such a disturbance.

The US commercial banking system does not seem to have behaved excessively seemingly due to only modest economic growth, strong regulatory oversight, and structural changes.

The thing this analysis does not take into account is the growing presence of non-bank organizations that have grown substantially during the current economic recovery.

Patrick Jenkins, writing in the Financial Times, warns that “Banks Seem Doomed to Repeat Lending Mistakes of Past Crisis” and spreads the cloud of doom by quoting the infamous statement of Chuck Prince, former chairman of Citigroup, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Mr. Jenkins goes on by writing, “In truth, bank lending in 2018 looks a lot like bank lending pre-2008.”

“Worse, macroeconomic policies, designed as a methadone fix to see a debt-addicted world through the post-crisis years, have actually led to increased leverage outside the banking sector: in aggregate, global debt now stands at close to $250 trillion, according to the Institute of International Finance, nearly 40 percent more than in 2008.”

And, what has the debt financed? Mr. Jenkins that in the artificially low interest rate environment of today, money has flowed into “Florida apartments to fine art” raising asset prices to “record levels.”

Most notoriously, the money has flown into commercial property.

But, the only examples Mr. Jenkins gives are from the UK. And, then he extrapolates from there to the world.

He doesn’t even mention the banking problems in, say, Italy, where the budget proposals of the current, populist government, are clashing with the leaders of the European Union and are driving up the yields on government bonds, which threaten the solvency of already weak Italian banks.

Mr. Jenkins does argue that the growing activity of non-banks adds to the riskiness of the current situation, but then leaves it at that.

Given this analysis, I wanted to see how the United States banking system was behaving within the current environment. So, I took a look at the Federal Reserve’s H.8 release on the Assets and Liabilities of Commercial Banking.

Interestingly, the information on the US commercial banking system did not leave me overly concerned with the state of bank lending. With respect to the 25 largest domestically chartered banks in the United States, I was actually surprised by how modestly they performed over the past year.

From August 2017 through August 2018, the Loans and Leases at these “large” banks only increased by 2.1 percent, a very modest number. The largest increase in the lending area came in Commercial and Industrial Loans… business loans… that rose by 3.6 percent, year-over-year.

In the area that Mr. Jenkins was particularly concerned about, commercial real estate, the 25 largest domestically chartered banks actually oversaw a decrease in loans of 1.1 percent, year-over-year. Not too aggressive.

Note that the 25 largest commercial banks in the country hold 56 percent of the total banking assets in the industry. The five largest banks are reported to hold a little less than 50 percent. These data are reported in my October 8 post on Seeking Alpha.

The rest of the domestically chartered banking system, a total of 4,808 commercial banks, control 30 percent of the total assets of the banks in the United States, were more aggressive than the largest banks.

Total loans and leases at these banks rose by 9.2 percent, year-over- year in August 2018.

Business loans at these “smaller” banks increased by 11.2 percent, while commercial real estate loans increased by 7.8 percent.

Obviously, the “smaller” banks were much more aggressive in their lending activity. This has been the case throughout the current economic recovery from the Great Recession. Apparently, they had to, as Mr. Jenkins states in his article, “support their clients.”

What about the longer-term, since the start of the current economic recovery?

Loan growth in both categories increased more rapidly at the “smaller” institutions.

Commercial and industrial loans rose by 42 percent at the “smaller” banks from August 2009 to August 2018, while they increased by only 36 percent at the 25 largest banks.

The difference in commercial real estate loan growth, however, was quite substantial… 34 percent versus 11 percent. It should also be noted that commercial real estate lending is more closely tied to “local” banks that are “smaller” in size. In August 2018, commercial real estate loans at the “smaller” 4,808 banks were slightly more than twice the amount on the books of the 25 largest.

Mr. Jenkins does contend that banks are not in as bad shape now as they were in 2008 and “banks do appear to be showing more caution than they did in 2007-2008.”

However, we just don’t know how the changes in the banking space over the past 10 years or so will be impacted by the “less controlled” and “less accountable” non-banks, especially if there is a disruption in the financial markets.

I have two responses to this. First, the commercial banks in the United States have been rigorously regulated over the past nine years and the loan expansions recorded during this time period are very modest within a historical context. The commercial real estate loans at the “smaller” banks have increased, on average, by less than 4 percent per year. This is very modest… and controllable. I don’t believe that we have to be overly concerned about this growth.

Therefore, I don’t see commercial bank lending in the shape it was pre-2008.

The debt problem lies elsewhere… primarily in the area of the growth in government debt. And, these problems will be exacerbated as central banks, like the Federal Reserve System and the European Central Bank, attempt to reduce the size of their securities portfolios in an effort to get back to “more normal” times.

This reduction, along with a rise in the yields of longer-term government securities…like has happened in the United States… could also impact banks portfolios in weaker economies, worldwide.

In general, however, the United States banking system is in relatively decent shape. Furthermore, a lot of other things are going on in the US banking system at this time and the largest banks may be putting more emphasis on these changes and staying very conservative in terms of their lending. The “smaller” banks want to stay in good shape because there is a lot of M&A activity going on amongst these banks and they want to get “good prices” as their number continues to shrink. In this sense, the situation is not lie pre-2008.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.