The Latest Lending Data Could Signal Trouble Ahead

The Latest Lending Data Could Signal Trouble Ahead
Stéphane Renevier, CFA

10 months ago2 mins

Once a quarter, the Fed asks the bankers responsible for giving out loans (i.e. senior loan officers) about their lending standards and how much demand there is for new credit. Results for last quarter – released just a few days ago – aren’t very encouraging.

Banks didn’t just report a weaker demand for loans, they also reported having tightened their lending standards (red line), making it harder to get a loan. They cited a “less favorable or more uncertain economic outlook, a reduced tolerance for risk, and the worsening of industry-specific problems” as reasons for doing so. What’s more, they appear to be bracing for a bleaker future: saying they expect loan demand, credit standards, and loan quality to all deteriorate.

Historically, this hasn’t been a great sign: a sharp tightening in lending standards preceded both the dotcom bubble and the global financial crisis. And that makes sense: banks aren’t likely to lend if they think consumers will default on their loans, so when they tighten their standards, that usually means they see a dark economic outlook. Making matters worse, people and businesses consume and invest less when credit is harder to get. So tighter standards tend to also lead to more economic weaknesses.

Investors don’t seem fazed by all this: the premium they require for holding riskier low-grade bonds over “risk-free” bonds (black line in the chart) is back to low levels – indicating that investors remain confident that even the riskier companies will be able to repay their debt. This is a big leap of faith, in my view. Now, you might not want to go as far as shorting high-yielding bonds – although buying “put” options on the iShares iBoxx $ High Yield Corporate Bond ETF (ticker: HYG; expense ratio: 0.48%) may not be a bad idea. But you should probably take it as a fresh warning signal that optimism may be overshadowing reality in some quarters.



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