How long will the lending spurt last?

Lending momentum proved strong through the first half of the year and into August. But a slowing economy and steps taken to combat inflation could signal an end to the boom times.

The story so far: U.S. banks’ second-quarter loans grew 4% from the prior quarter and 10% from a year earlier, according to a Keefe, Bruyette & Woods analysis. Community and regional banks led the charge, with sequential growth of more than 5%.

In all, KBW said, 94% of banks posted quarter-over-quarter loan growth and 99% reported year-over-year expansion. The sequential and annual rates of growth in the second quarter both accelerated from the first quarter. And  halfway through the third quarter, Federal Reserve data point to continued growth of about 3% from the end of June.

Analysts and bankers say that commercial loan demand gained momentum as businesses borrowed to invest in growth, including new hires to meet demand for products and services that rebounded from pandemic-era lows. Confident consumers also began to use credit cards more.

However, recession fears have mounted because of soaring inflation — consumer prices reached 40-year highs this summer — and a surge in interest rates. The Federal Reserve has boosted rates multiple times this year and signaled more hikes lie ahead to combat inflation. Historically, in periods of rapidly rising rates, spending and borrowing slows. Prices tend to decline as a result, easing inflation, but the economy often tips into recession. To avoid losses, banks tend to pull back on lending amid economic downturns.

“We will see caution around inflationary pressures and the impact that rising rates will have on lending,” said Daniel Goerlich, banking and capital markets deals leader at PwC.

Homes stand in this aerial photograph taken above Toronto.

Housing markets and mortgage banking are under pressure as interest rates soar.

Bloomberg News

Chris Nichols, director of capital markets at the $46 billion-asset SouthState Corp. in Winter Haven, Florida, said many banks’ underwriting standards are sure to become increasingly conservative in the second half of 2022. Lending will likely slow before the end of the year, he said, as banks become more selective and as borrowers balk at rising interest expenses.

“Higher rates are going to slow everything down,” Nichols said.

Analysts at D.A. Davidson hosted a conference last week involving more than 20 banks. The analysts said in a report recapping the event that bankers are clearly “more cautious” now than earlier in the year.

“Credit and recession risk was a consistent topic of conversation,” with many banks “noting an elevated level of existing portfolio review, along with more aggressive stress testing of new credit requests,” the D.A. Davidson analysts said.

They added that loan pipelines are smaller now than in the first half of the year, and they projected the pace of loan growth would decelerate substantially over the final months of 2022.

Michael Jamesson, a principal at the bank consulting firm Jamesson Associates, said a pullback in lending is almost inevitable. The one-two punch of higher prices and spiking interest costs will push would-be borrowers to delay plans, he said.

“People just can’t keep up with the cost of everything,” he said. “We’ve already seen this with residential mortgages, of course.”

Indeed, applications for loans to buy homes in the week ended Aug. 12 declined 18% from a year earlier, according to the Mortgage Bankers Association. Refinancing activity plunged 82%.

“Home purchase applications continued to be held down by rapidly drying up demand, as high mortgage rates, challenging affordability and a gloomier outlook of the economy kept buyers on the sidelines,” said Joel Kan, the MBA’s associate vice president of economic and industry forecasting. 

The 30-year fixed-rate mortgage averaged 5.13% last week, up sharply from 2.86% a year earlier, according to Freddie Mac.

“The market continues to absorb the cumulative impact of the large price and rate increases that led to a plunge in affordability,” said Sam Khater, Freddie Mac’s chief economist. “As a result, over the rest of the year purchase demand likely will continue to drag.”

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