It may bolster capital ratios. It may even signal a healthy deleveraging in an economy that choked on its own excess. But long term, shrinking a loan book is no way to run a bank.

Yet that is precisely what is happening at most national and regional lenders, as customers, especially in the commercial arena, wait out the economic downturn.

It is a sharp contrast from a year ago, when middle-market and corporate borrowers drew heavily on their credit lines in response to the lockdown in the capital markets — a phenomenon that prompted banks to reduce lines where they could to limit exposure and shore up capital.

Now, the weakness in the economy has pushed credit line utilization rates to levels that many banks' chief executives are describing as the lowest they've ever seen. That has decreased the asset base from which banks can generate fees. Worse yet, analysts say, a contraction in loans could raise concerns about whether the best customers are paying off debt, which would leave banks with a higher concentration of lower-quality credit.

But mostly, a drop-off in lending speaks to the still-fragile state of the broader economy.

"Companies are accumulating cash, cutting expenses and are scared to death to borrow for expansion and growth," said Robert Patten, an analyst at Regions Financial Corp.'s Morgan Keegan & Co. Inc.

Those trends helped to shrink the loan portfolio at SunTrust Banks Inc. to $116.5 billion at the end of the third quarter, down 5.2% from the prior quarter and 8.1% from the same quarter a year ago. Mark Chancy, SunTrust's chief financial officer, told analysts on a conference call that a majority of the decline was tied to commercial loans, which fell $3 billion, or 8%, from the second quarter.

Fifth Third Bancorp had a 1% quarter-to-quarter drop in consumer loan and lease balances, and a 2% drop in commercial balances. And at PNC Financial Services Group Inc., $83 billion of loans and commitments originated over the past nine months were not enough to stop the Pittsburgh company's loan book from ending the third quarter $15 billion lighter than it was at the start of the year.

Even as the economic downturn begins to reverse itself, banks may have to wait for loan growth to return.

"At some point, [commercial customers] have to go back and replenish inventory, but it won't be until sales go up that people will buy additional inventory and borrow money to buy extra things," PNC Chairman and CEO James E. Rohr said in an interview. "That means the economy has got to come back more strongly than it is today."

Until then, banks will have to look elsewhere for extra juice to add to the bottom line.

"Obviously, loan demand has to come back to help see balance sheet growth," Fifth Third Chairman and CEO Kevin T. Kabat said in an interview. "We do have plenty of liquidity though, and deposit growth. And there may be some slight opportunity in terms of the investment side of the house. But we'll be cautious from that perspective."

In any case, banks these days have little interest in chasing business just for the sake of generating loan growth — despite what some critics may say about the need for banks to issue more credit to help the economy along.

"Simply looking at one side of the ledger or the other doesn't solve the problem," Kabat said. "Putting out good money to good operations and good uses is very beneficial for the economy. Putting out money to bad [credits] is not very helpful."

The problem for banks is that even good credits are making do with less borrowing.

At U.S. Bancorp, average credit line utilization by corporate and commercial customers was 32% in the third quarter, which Chairman and CEO Richard K. Davis said was a record low since his team has been tracking the data.

The falloff from the 35% rate the previous quarter "doesn't sound like a lot," Davis told analysts this week on a conference call, "but when you take it on $100-plus billion and you lose a couple of percentage points, it's meaningful."

But the contraction in loan portfolios is not entirely a demand problem — at least not in some lines of business. Huntington Bancshares Inc., for example, has been intentionally reducing its commitments to struggling home builders and retail property owners through balance reductions, loan sales and chargeoffs.

At the end of the third quarter, Huntington's commercial loan portfolio was 4% smaller compared with the second quarter and 7% smaller than a year earlier. But with borrowers no longer able to tap the commercial mortgage-backed securities market for credit, Huntington, of Columbus, Ohio, continues to have strong demand for commercial real estate loans.

"There is as much CRE demand as you want to make loans," Chairman and CEO Stephen Steinour said. Huntington's CRE book declined by a scant $300 million — or 3% — from the second quarter to $8.9 billion. And that includes $169 million in CRE loans charged off in the quarter.

Commercial credit quality continues to be one of the top issues facing Huntington. The company lost $166.2 million in the third quarter, compared with a loss of $125.1 million in the previous quarter.

High credit costs left Fifth Third with a loss of $97 million, compared with second-quarter earnings of $882 million and a year-earlier loss of $56 million. PNC more than doubled its profit from the prior and year-earlier quarters, to $559 million, aided by declining deposit costs.

Atlanta-based SunTrust posted a loss of $377.1 million, compared with a $243.6 million loss in the second quarter and a $304.4 million profit a year earlier.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.