It’s time to pay attention to commercial and industrial loans


This strong indicator of recession is beginning to worry me again.

Through Wolf Richter for LOUP STREET.

Commercial and industrial loans (C&I loans) at all commercial banks fell to $ 2.33 trillion on January 1, the lowest since March 2019, according to Federal Reserve data on commercial banks, released Friday. C&I loans peaked in August last year at $ 2.38 trillion and have since fallen 1.7%. This happened despite three rate cuts by the Fed during the period.

C&I loans are used by businesses for working capital or to finance capital expenditures. Working capital loans are generally secured by receivables and inventory. Capital expenditure loans are secured by equipment and the like.

These loans are often lines of credit with variable interest rates – very low and very attractive to borrowers. And the banks are eager to extend these loans and are aggressively offering them even to my small business. So there is no problem on that side of the equation.

But business demand for these loans is a sign of economic activity, a sign that businesses are expanding or downsizing. And demand is falling.

The graph shows the year-over-year percentage change in these loan balances. Note the relationship between year-over-year declines (below the red line) and recessions. If loan demand suddenly bounces back over the next two or three months, I would say the US economy has passed that particular hurdle. But if the trend since August continues to move south and ends in the neighborhood of -3% or worse, a different scenario would emerge:

Year-over-year growth rates were around 10% from late December 2018 to March 2019, then demand started to falter. As of January 1, 2020, year-over-year growth had fallen to 0.6%.

The decline in 2015-16 was associated with the oil crisis and industries related to oil and gas extraction, including manufacturing, trucking, and specialized segments of the technology and service sector. The C&I loan balance fell by $ 30 billion between the November 2016 peak and March 2017, before starting to rise again. But the growth rate never turned negative year over year and a recession was avoided. In 2016, GDP growth was only 1.6%, the slowest since the financial crisis.

We are now back in the same scenario, only worse: So far, loan balances have fallen by $ 42 billion in four months, from the peak of August 2019 to January 1, 2020.

The fall in rekindled oil scraps has something to do with this, although the price of oil remains more than twice as high as during the 2016 low, and the drop in oil today is not as fierce. than it was at the time.

Today, other things are triggering the lack of demand for C&I loans, such as the widespread slowdown in manufacturing and the freight sector (aside from last mile delivery for e-commerce). C&I loans are a larger measure of economics, which is not limited to manufacturing. Many service companies have C&I loans to finance equipment purchases or for working capital, secured by receivables.

C&I loans, in a growing economy, are growing rapidly because they are directly linked to business activity, for a wide range of businesses. And in the past, when the demand for loans declined dramatically, a recession loomed. So far, C&I loan balances have fallen 1.7% from the August high and are still up from a year ago, but just 0.6%. And if loan demand does not rebound quickly and continues to decline, it will be time to rekindle the talk about the recession:

And more rate cuts won’t help in that regard. Interest rates are already low, and it is not the cost of debt that prevents companies from taking out C&I loans. It is the lack of business on their part. C&I loan balances increased in 2018 and 2019, even as interest rates increased. But balances began to fall just weeks after the first rate cut at the end of July. Here is an overview of C&I loan balances over the past two years:

However, what happened during the financial crisis was special, in terms of my life: credit froze; banks, some of which were collapsing, stopped lending; businesses have stopped asking for loans; and C&I loans have plunged off a cliff. This is not the scenario on the horizon at the moment.

The typical scenario would be something like the previous two recessions where the business cycle takes its toll, where a wave of corporate debt restructurings and bankruptcies reduce overdue debt to the detriment of investors and banks, and where businesses shrink, and loan balances shrink due to lower demand, tighter credit standards and debt restructurings.

The US economy is not there yet. C&I loans have not yet reached this point and could rebound in the coming weeks or months. But if they continue to move south, the recession scenario is a big step forward.

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