U.S. banks are doling out fewer loans to businesses as lending standards tighten and demand weakens after 11 interest-rate hikes by the Federal Reserve, suggesting that economic growth could slow as credit contracts.
The volume of commercial and industrial loans that banks dish out to companies shrank by about 0.2% in September, marking a sixth straight month of declines, according to the Fed’s latest batch of H8 data. The extended stretch of declines is spurring some market watchers to fret that the economic deceleration the Fed has been trying to engineer to curb inflation is now closer on the horizon, and may turn out to be quite painful.
Less borrowing often reflects declining investments by businesses and a fall in hiring activity, which in turn weighs on economic growth.
“A slowdown in lending is starting to bite the economy,” said Matt Eagan, portfolio manager and co-head, Full Discretion Team, at Loomis Sayles & Co. “We are starting to see corporations signaling about weaknesses in consumption. Forward looking guidance is not so rosy.”
The fears come just as the U.S. stock market finished its best week in nearly a year, while the distress ratio for riskier companies is below the post-global financial crisis average and spreads on U.S. investment-grade bonds have barely budged.
But that risk-on mood is no longer sustainable.
Over the next 12 months, U.S. high-yield bond and leveraged loan issuers are expected to default at rates of 8% and 7.6%, Hans Mikkelsen, TD Securities’ managing director of credit strategy, wrote in a Monday note. The average default rate for the two asset classes going back to 1996 is 4.6% and 3.3%, Mikkelsen said.
He also points out that while the net share of banks tightening lending standards for medium- and large-sized firms fell to 33.9% in the third quarter from 50.8% in the previous quarter, per the Fed’s latest loan officer survey, that figure is still historically high.
Meanwhile, corporate share buybacks and dividends are down 5% year-over-year through the second quarter, according to a JPMorgan Chase & Co. report Tuesday. “This is evidence that higher rates are having their logical intended impact on corporate balance sheets,” strategists led by Eric Beinstein wrote. Companies are shifting to more equity—by buying back or paying out smaller amounts—and less debt on their balance sheets, they noted.
Businesses on weaker financial footing will be more vulnerable to a possible economic downturn. The riskiest borrowers are being choked off from access to credit, while investment-grade firms and higher-quality speculative-grade issuers are still enjoying access to the markets, albeit at higher rates.