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Bank Lending Continues to Plunge

March 3rd, 2010 9:31 AM by Lehel S.

Bank Lending Continues to Plunge

The FDIC reported last week that bank lending shrank at a record pace in 2009.  The lead article in the Wall Street Journal last Tuesday read: “Lending Falls at Epic Pace.”   How true, unfortunately.  Last year, US banks posted their sharpest decline in lending since 1942, suggesting that the industry’s continued slide is making it harder for the economy to recover.   

While top-tier banks are recovering at a faster clip, the rest of the industry is still suffering, according to a quarterly report from the Federal Deposit Insurance Corp (FDIC).  Banks fighting for survival, especially those plagued by losses on commercial real estate (as I have written about often recently), are less willing to extend loans, siphoning credit from businesses and consumers.

Besides registering their biggest full-year decline in total loans outstanding in 67 years, US banks set a number of other grim milestones last year.  According to the FDIC, the number of US banks at risk of failing hit a 16-year high at 702.  More than 5% of all loans were at least three months past due, the highest level recorded in the 26 years the data have been collected.  

Bad News For BusinessAnd the problems are expected to last at least through 2010.  FDIC Chairman Sheila Bair said that banks are “bumping along the bottom of the credit cycle,” and that the number of bank failures in 2010 will likely eclipse the 140 recorded last year.

The FDIC’s latest report revealed that asset-quality indicators for banks continued to deteriorate in the 4Q as borrowers continued to fall behind on their loans. Banks wrote down $53 billion in loans in the final three months of last year. The quarterly write-off rate was the highest ever recorded in the 26 years the FDIC has collected the data. A total of $391.3 billion of all loans and leases, or 5.4%, were at least three months past due at the end of 2009.

The fact that banks are not lending remains a problem for policy makers who are eager for banks to lend again.  Lawmakers on Capitol Hill and administration officials have pushed banks to lend, particularly in light of the billions in taxpayer aid injected into the financial industry over the past two years.  But banking groups and their members counter that they are under pressure from regulators to be more prudent in their lending practices, and that demand from struggling consumers and businesses isn’t there.

Initiatives such as the Obama administration’s $30 billion small-business lending program will rely on banks’ making loans at a time when many of those same firms are wrestling with a rising tide of commercial-real-estate problems (as I have chronicled previously), or they are being told to add to reserves by regulators.

The FDIC said that the decline in loan balances in the 4Q hit all major categories—from construction to commercial loans and residential mortgages.  Only credit-card loans increased in the 4Q.

It remains unclear whether the sharp decline in loans outstanding stems from banks’ tightening standards and a fear of lending or from weak demand from potential borrowers still spooked by the recession.  Frankly, it seems obvious it’s a combination of both.  FDIC Chief Economist Richard Brown recently noted: “Lending has been weak and spending by businesses and consumers has also been weak.”

A January survey by the Federal Reserve of senior loan officers showed banks have slowed their efforts to tighten lending standards, but have not backed off the more stringent loan terms they put in place over the past two years.  The same report, however, also showed that demand for loans from businesses and consumers continues to fall.  Bankers, on the other hand, say creditworthy borrowers are hard to come by.

The FDIC Chairman Sheila Bair said officials are eager for banks to make loans in their communities, putting the onus on the bigger institutions to do more small-business lending.  “The larger institutions I think need to step up to the plate here too,” Ms. Bair said, describing as “significant” the declines in their loan balances and credit lines over the last two years.

Lawmakers who are pushing banks to lend more are coming to realize the magnitude of troubled commercial-real-estate loans (you read it here first). The FDIC’s Mr. Brown said these loans take longer than residential mortgages to go bad, dragging out the hit to a bank’s balance sheet.

The FDIC’s Mr. Brown concluded: “While the economy is moving ahead, banking results tend to lag behind.  The problem loans and the earnings of the industry will improve somewhat after the economy improves.”

As the chart above illustrates, bank lending remains in freefall.  While the FDIC report suggests that most banks are no longer tightening their lending standards, there is little or no evidence that they will relax them anytime soon.  Likewise, it remains to be seen when, or if, demand for commercial loans will begin to rise among small and medium sized businesses.

None of this is good for the economy, and this is a big reason why I expect GDP growth to disappoint this year.  While the credit markets may not be frozen as they were in late 2008, they are still at least frosty.

Posted in:General
Posted by Lehel S. on March 3rd, 2010 9:31 AM

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