Banks Report Loan Demand Is Weakening

|
Includes: AAPL, AMZN, BTO, DPST, FAS, FAZ, FINU, FINZ, FNCL, FTXO, FXO, IAI, IAK, IAT, IYF, IYG, JHMF, KBE, KBWB, KBWP, KBWR, KCE, KIE, KRE, PFI, PSCF, QABA, RWW, RYF, SEF, SPY, UYG, VFH, WDRW, XF, XLF
by: Eric Basmajian
Summary

Banks reported weakening loan demand across nearly all categories of loans.

Despite the rally (bounce) in the stock market, growth conditions continue to decelerate.

Should this be viewed as a warning sign?

Banks Report Loan Demand Is Weakening

The latest data point that confirms the deceleration in global and domestic economic activity comes in the form of the Senior Loan Officer Opinion Survey by the Federal Reserve. In this report, responses from 73 domestic banks and 22 U.S. branches of foreign banks were collected from December 21, 2018 - January 7, 2019, judging the conditions of lending standards (tightening standards or loosening standards) and the demand for loans across several categories such as real estate, auto loans, C&I loans and more.

This report, while a survey, provides a good proxy into the loan demand reported by banks themselves.

Many followers and members of EPB Macro Research have been following the global slowdown bleed into the US leading indicators and this report confirms that to be the case.

The results of the latest Senior Loan Officer Survey corroborate the deceleration in global economic data and the weakness in the US leading indicators such as housing in reporting weaker demand for loans across nearly every metric.

Results Of The Survey

From a high-level summary, banks reported that tightening lending standards were expected in the future, demand for loans had weakened and future performance of loans will deteriorate for all categories surveyed. This is not a cherry-picked bearish narrative as we will dive into the actual report and hear what the banks had to say for themselves.

Starting with business lending, banks reported that lending standards for C&I loans remained basically unchanged while the risk premiums on loans (spreads) have started to increase.

The most common reason for tightening lending standards was a less favorable or more uncertain economic outlook.

C&I Loan Lending Standards:

Source: Federal Reserve

Banks reported weaker demand for C&I loans citing consumers desire for loans to finance M&A and plant and equipment had waned. At EPB Macro Research, we have been covering the deceleration in capital spending at length and have also written extensively on the widening of corporate spreads leading to a reduction of debt-financed share buybacks and M&A, as reported by the banks. For a recent note on corporate spreads, click here.

Demand For C&I Loans:

Source: Federal Reserve

Moving on to commercial real estate lending shows essentially the same results; tightening lending standards and weakening demand.

Demand For Commercial Real Estate Loans:

Source: Federal Reserve

After questions related to business lending, senior loan officers are surveyed on the conditions related to household lending. The results showed a greater deterioration in the survey of household lending as significant shares of respondents reported weaker demand as compared to a moderate net share of respondents reporting weaker demand for business loans.

The weak housing data, covered extensively at EPB Macro Research and in public research notes such as the following title, "Toll Brothers Confirms The Housing Slowdown - What's Next?" are proven to be accurate and the pressure on residential real estate is unlikely to subside based on these reported results.

Residential Real Estate Lending:

Source: Federal Reserve

As the personal savings rate continues to dip and total income growth decelerates, despite the myth of average hourly earnings, demand for consumer loans is decelerating. The consumer health is deteriorating and as the leading economic indicators suggest, a slowdown in consumption activity is likely to become more apparent in the quarters ahead.

The early signs of a strong consumer pullback based on decelerating economic conditions and weaker income growth can be seen in the vast amount of companies slashing forward guidance including Apple (AAPL) and Amazon (AMZN).

Consumer Lending:

Source: Federal Reserve

Some of the most important and interesting information from this report comes from the special questions section. Senior loan officers are asked about their forward expectations on lending conditions if economic activity progresses as forecast. In other words, this is the base case. If conditions fall short of expectations, which I expect they will, then the results from banks in Q1 and for the rest of 2019 are likely to underwhelm expectations. At EPB Macro Research, we have been short regional banks (KRE) since the summer of 2018 and have published several notes on the thesis, citing all of the information that is now just coming out in the senior loan officer survey.

The most alarming part of the report comes from the forward outlook in which the base case from banks is that on balance, banks reported expecting tighter standards, weaker demand, and worse loan performance for most loan categories, a troubling sign.

Special Questions & Forward Outlook

Source: Federal Reserve

Banks even mentioned the likelihood of delinquencies and other loan metrics to deteriorate in the future.

These are conditions that we have been writing about are often dismissed, without even looking at the data presented, because anything that points towards weaker conditions is met with firm pushback. Now, banks themselves, are saying weaker conditions are ahead.

Special Questions & Forward Outlook

Source: Federal Reserve

For those who are more visually inclined, below are a series of images that show the net percent of respondents reporting tighter conditions and stronger loan demand across all categories.

Measures Of Supply & Demand For C&I Loans:

Source: Federal Reserve

The demand for commercial real estate loans is moving towards the lowest level since 2009.

Measures Of Supply & Demand For CRE Loans:

Source: Federal Reserve

As reported above, standards for consumer loans are tightening and demand is slipping.

Measures Of Supply & Demand For CRE Loans:

Source: Federal Reserve

I never would suggest making investment decisions or forming an outlook on any single economic data point or survey but this newly updated information is certainly part of a comprehensive economic outlook that has its foundation in the hard economic data reported on a weekly and monthly basis.

The leading economic indicators in the United States continue to point lower while the coincident data in the rest of the world, specifically Europe, is closer to a recession.

As I write to members of EPB Macro Research on a consistent basis, there is no recession in the data yet for the United States, just clear evidence that growth conditions will continue to deteriorate and are not in any way ready to turn higher yet. The stock market is not the economy and a prolonged rally in the S&P 500 does not mean buying stocks is the most prudent investment idea at this time when the risk of correction runs elevated relative to history during periods of decelerating global and domestic economic conditions.

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.

Additional disclosure: Underweight position in SPY
Short KRE