Commercial lending’s best days may be long gone

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The stars have unquestionably aligned for the nation’s biggest banks, which have benefited in recent months from corporate tax cuts and efforts to loosen post-crisis rules.

But scratch the surface of a big bank’s balance sheet, and there's plenty to worry about.

Commercial loan demand — a big driver of profits — is in the dumps. It has been for two years, and there’s no clear sign it will change anytime soon. After growing at a double-digit pace in late 2015, lending to businesses petered out to just below 1% in the first quarter from a year earlier.

So if loan growth isn’t coming from businesses, where will it come from?

It’s not immediately clear. During a pair of dueling industry conferences in New York this week, big-bank CEOs were asked about their expectations for loan growth in the year ahead. Several held off on offering predictions, noting that an upswing in business confidence just doesn’t square with the downturn in lending.

That’s worrisome — and not just because tepid loan demand weighs on the bottom line. Bankers often brag about their credit discipline, but weak demand can create big incentives for executives to start loosening underwriting terms to drum up business. What follows is often a slow creep: What looks like a reasonable exception for a longtime customer today — a more lenient covenant, for example — may snowball into a problem loan down the road.

For banks with goals to meet and investors to impress, the temptation to cut corners, even slightly, can be strong. And, according to a recent report, many bankers have started to succumb to it.

In a semiannual report on risk, the Office of the Comptroller of the Currency said last week that commercial credit standards have loosened across the industry. After years of tightening standards, more banks have begun easing up, extending interest-only terms and underwriting loans with higher loan-to-value ratios to customers.

“This incremental easing was influenced by banks’ desire for interest income and loan growth to meet strategic objectives amid a competitive credit market that is affecting all sizes of banks,” the OCC said in its report.

The OCC’s warning is just the latest chapter in a story that has perplexed the industry for nearly two years. As commercial lending has slowly decelerated, bankers have cycled through a number of different explanations about what’s going on.

First there was geopolitical uncertainty in the second half of 2016, following Brexit and the surprise election of President Trump. Then there was the desire among borrowers for more clarity on Republicans’ legislative priorities, including repealing Obamacare and cutting taxes.

More recently, the influx of cash from the tax cuts, which were signed into law last year, has been blamed for the lackluster demand. And all the while a push among big companies to refinance bank debt in the capital markets has been cited as a contributing factor.

If banks have any luck at all in the matter, it’s in their timing. A mix of higher interest rates and lower taxes have helped to offset the impact of dismal commercial lending results in banks’ quarterly earnings.

In fact, banks had their most profitable quarter on record during the first three months of the year, according to the Federal Deposit Insurance Corp.

But amid all of their winning, big banks have also been forced to grapple with the possibility that commercial lending — the lifeblood for large regionals — may never fully come back. Business lending at small banks, in contrast, has been mostly steady.

During a presentation Wednesday morning, U.S. Bancorp CEO Andy Cecere was asked by an analyst if the downturn is indicative of a bigger economic shift. Rather than investing in equipment and new buildings, is it possible that companies are investing more in technology, cloud computing and less capital intensive items?

“There could be a little of that,” Cecere said. Still, he said, the demand for bank loans is out there — customers have simply deferred making big investments, or taking on bank debt, for the time being.

“I do think there is a lot of decision-making around growth, expanding, moving, acquiring that was put on hold for a while,” Cecere said.

Time will tell.

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