Business loan demand bounces back, US banks are ready

More business owners are looking for loans in the third quarter, and U.S. banks are more than ready to book the credits.

A Federal Reserve survey of senior loan officers, released Aug. 2, showed stronger demand for nearly all loans in the third quarter, including among large business owners, one of banks' most important client demographics. Roughly 31% of loan officers reported stronger demand over the last three months for loans to large- and middle-market firms. That compared to 25% of loan officers reporting weaker demand, with the remainder reporting roughly similar demand. With a net positive of 6%, it was the first report in over a year to show more officers than not reporting stronger demand for large commercial-and-industrial, or C&I, loans.

"The senior loan officer survey was very encouraging. In the C&I area, in particular, you saw the demand number quite a bit higher," said Gerard Cassidy, an analyst for RBC Capital Markets, in an interview. "That should bode well for total loans growth this year and next year."

Most banks have reported shrinking loan balances in the first half of the year, limiting the industry's ability to deliver on a key profitability plank: earning assets growth. Borrowers uncertain about the economic recovery and flush with cash from government stimulus programs have been hesitant to take on debt. Further, borrowers with loans from the Paycheck Protection Program, an emergency government program launched near the pandemic's onset, are seeking forgiveness, causing those loans to roll off banks' balance sheets.

Forgiven PPP loans continued to weigh on C&I loan balances in the Fed's latest H.8 report, a data release that shows deposits and assets across the industry. C&I loans were down 0.1% from the prior week and 14.0% lower from the year-ago period, with data as of the week ended July 21.

During second-quarter earnings calls, several bankers reported signs of a turnaround even though loan balances continued to shrink for most banks. Among larger banks, Bank of America Corp. reported signs of a bottom, and Truist Financial Corp. executives said they were confident green shoots were in the offing. Notably, executives at JPMorgan Chase & Co., the nation's largest bank, said the second half would be a "bit of a slog" for loan growth.

The Fed's loan officer survey suggested a turning point for loan growth could be on the horizon. Lenders reported stronger demand across several loan types. In addition to large- and middle-market firms, more lenders reported strengthening loan demand from smaller firms. Consumer products also saw improvement, with significant gains in the reported demand for both auto loans and credit cards.

Meanwhile, bankers reported that their companies were easing underwriting standards for the same products. One part of the survey asked loan officers how underwriting standards compared to the midpoint of lending standards from 2005 through the present. The majority of respondents said standards were easier or the same, suggesting a return in credit standards to pre-pandemic levels.

"Traditionally, coming out of recession, banks are reluctant to lend again because they had their heads handed to them during the recession. This one is totally different. Banks are eager to lend and it's all about convincing borrowers to borrow," Cassidy said.

Other analysts also saw a potential turn in loan growth in the Fed survey. Ken Usdin at Jefferies LLC wrote that commercial real estate, as well as C&I, saw loan demand turn positive in the latest report after being negative in the prior survey. Usdin also wrote that loosened standards in C&I, which showed up in the latest report, tend to correlate to strong C&I loan growth after accounting for a six-month lag.

"Banks are clearly willing to lend and to give on price to utilize cash/deposits," Usdin wrote, pointing to the excess liquidity on banks' balance sheets.

Indeed, deposits continued to grow in the latest H.8 report, coming in at $17.278 trillion, a 0.6% increase from the prior week and 11.4% higher than the year-ago period.

Michael Rose, an analyst for Raymond James, also highlighted the fact that stronger demand and loosened underwriting standards appeared to persist across almost all loan types in the latest survey.

"While the delta variant could slow the economic recovery, all signs point to increasing loan demand and net growth as the economy moves further away from the depths of the pandemic and PPP forgiveness wanes," Rose wrote in a note.

RBC's Cassidy said historical data suggests a tight relationship between nominal gross domestic product growth and total loan growth. With inflation on the rise and an economic recovery taking hold, Cassidy said banks could report significant loan growth in 2022.

"If the relationship between those two numbers hold ... we're going to see double-digit loan growth next year. No one is forecasting that, nor are we, but it's a possibility," he said.