As we move through the second half of 2023, debate around hard-landing, soft-landing, or no-landing scenarios continues to grab headlines. We have been providing updates on economic trends in growth and inflation measures that would suggest we are in a similar environment to prior economic slowdowns. To dive deeper into that analysis, we have shifted our attention to lending activity as it has historically been a good indicator of where we are in the cycle. At its core, it is a measure of commercial banks ability and willingness to lend, which is a key driver of real economy activity. If growth was going to accelerate in the near term, we would expect to see lending activity increase. If lending slows, coupled with the rest of the economic data, we would expect to see a continuation of the broader slowdown we have already observed.
We can monitor the weekly H.8 data from the Federal Reserve to get an overall gauge of banks lending appetite. For the week of July 21, loans and leases in bank credit across all commercial banks declined to $12,089.10 billion, slowing to 5.4% y/y. At the end of 2022, this measure was at $12,104.36 billion and accelerating at a y/y rate of 11.4%. This would suggest something changed in the banking sector that has led them to slow the pace of loan growth, which likely has negative implications for economic activity. Indeed, the y/y percent changes in the first twenty-eight weeks of the year have trended in a similar direction to prior economic slowdowns.
Underneath the all commercial banks category, we can look at lending from large and small banks. In summary, the trends are mostly the same, but the impact in different sectors of the economy can vary. Loans and leases from large banks have slowed to 2.7% y/y from 8.2% at the end of 2022 and are down from their cycle peak of 10.6% in the first week of October last year. The dollar amount has declined to $6,726.39 billion from $6,767.87 billion at the end of last year (-0.6% YTD, compared to +4.8% YTD through this period in 2022). Loans and leases from small banks have slowed to 9.6% y/y from 14.7% at the end of 2022 and are down from their cycle peak of 15.4% in the second week of February 2023. The dollar amount has increased to $4,344.16 billion from $4,278.50 at the end of last year (+1.5% YTD, compared to +6.3% YTD through this period in 2022).
As mentioned above, the economic impact of a credit slowdown can vary between large and small banks. For example, as a percentage of total commercial real estate lending, small banks carry more weight at $2,851.99 billion (approx. 65% of total small bank lending) compared to $2,485.16 billion from large banks (approx. 37% of total large bank lending). So far, real estate lending from small banks has decelerated to 12.7% y/y, down from 17.9% at the end of last year. On a year-to-date basis, CRE loan growth has accelerated 2.8% y/y compared to 7.5% through the twenty-eighth week in 2022. Real estate lending from large banks has also slowed to 2.0% y/y, down compared to 5.0% at the end of last year. On a year-to-date basis, CRE loan growth has decelerated to -0.03% y/y, down compared to 2.9% over the same stretch last year.
This earnings season, we have heard from many banks either commenting on the fact that their CRE exposure is insignificant compared to their total loan book or that they have taken measures to reduce their exposure to the sector.
“I think that when we talk about office, for example, our portfolio, as you know, is quite small, and our exposure to sort of so-called urban-dense office is even smaller. The vast majority of our overall portfolio is multifamily lending.”
– Jamie Dimon, JPMorgan Chase & Co.
“As a reminder, commercial real estate office credit exposure represents less than 2% of our total loans.”
– Alastair Borthwick, Bank of America Corporation
“While overall credit quality remains strong across our portfolio, the office category within commercial real estate continues to be a key area of concern.”
– Robert Reilly, PNC Financial Services
“We have limited exposure to leveraged lending, office loans and other high-risk categories. B and C class office exposure in Central Business Districts totaled $121 million. 2/3 of our commercial real estate exposure is in multifamily, including affordable housing.”
– Christopher Gorman, KeyCorp
“As we know, this is a topic of interest, we have included details around the commercial real estate portfolio, including the CRE office portfolio in the appendix of this presentation, beginning on Page 29. CRE represents 23% of our total portfolio with office representing 17% of total CRE or 4% of the total loan balances.”
– Paul Burdiss, Zions Bancorporation
From our point of view, the recognition of this negative setup provides some insight into where banks are at in terms of risk and their willingness to lend moving forward, and most likely not just in the CRE space. The takeaway from this dynamic is that looming commercial real estate risks could have an outsized impact on small banks, which could lead to further contraction in credit growth broadly.
In terms of broader takeaways, a slowdown in credit growth has historically coincided with negative economic setups and market performance. Looking at 2008 as one example, we see the S&P 500 Index and U.S. 10-Year Treasury yield drifted lower into the week that domestically charted commercial bank loan growth peaked. Around that same timeframe, a few months into the GFC, Nonfarm Payrolls started to go negative on a m/m basis. By the time that the dollar amount had peaked, the S&P 500 had already declined by roughly 40%. In the two months following the peak in value, the 10-Year Treasury yield declined by 200 basis points and the S&P 500 fell by an additional 29%. On the labor side, we also see a noteworthy change in how quickly the labor market deteriorated from the peak in loan value through the end of 2009. When access to credit becomes expensive or tough to get, businesses are forced to make adjustments to their cost structure, which tends to lead to layoffs.
Bringing the conversation back to which landing may occur, the direction of credit growth has moved in a direction that would not suggest real economic activity is going to accelerate in the second half of 2023. We will continue to monitor and provide updates on this data as we move through the year.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Economic Analyst
Boyd Watterson Asset Management, LLC