Business-Loan Drought Ends for Banks

Business borrowing is picking up, a welcome relief for banks and a sign of strength for the U.S. economy.

Preliminary second-quarter data from the Federal Reserve indicate the year-over-year growth rate of business loans rose to 5.5% in late June from less than 1% near the end of 2017. The upturn marks the reversal of a prolonged slump in business-loan growth that began in earnest about two years ago.

The rebound reflects increased confidence at companies. In April, Manvee, a Milwaukee-based wholesale bakery, decided to take out loans for more than $4 million from Indiana-based lender Old National Bancorp , ONB 0.53% said co-owner Thomas Roepsch.

“We’re trying to keep up with growth,” he said. “People are knocking on the door asking for more of our products.”

Manvee, which bakes doughnuts, muffins and other goods that are then sold at retail stores, plans to use the loan to expand into Indiana and invest in automation and delivery trucks, Mr. Roepsch said.

The potential spoiler is trade tensions, which could make businesses more cautious. The Federal Reserve’s rate-setting committee, at its June meeting, expressed concern about the effect tariffs and trade restrictions could have on future investment activity, according to minutes released last week. Contacts in some Federal Reserve districts “indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over trade policy,” they said.

For banks, the acceleration in lending may help lift results when firms report quarterly results this month. Profits from lending are a major component of bank earnings and grow when total loans increase or rates on loans rise. Business-loan growth often helps on both fronts because these credits typically carry floating rates that allow banks to capture rate increases.

“We’ve been waiting for this ever since the 2016 election,” Scott Siefers, a bank analyst at Sandler O’Neill + Partners said.

A slowdown in businesses’ appetite for bank loans began to gather pace in summer 2016, a few months before the 2016 presidential election. Lending growth, which had exceeded 10% for much of the prior two years, dipped into single digits.

Most bankers expected that optimism among business owners in the wake of Republican President Donald Trump’s surprise victory would lead to increased borrowing. Instead, loan growth continued to fall, reaching a rate of around 0.5% in December 2017.

The fall-off dampened bank profits. Just as troubling for bankers: Broader economic data was solid and there weren’t obvious reasons for the decline.

Some bankers attributed it to competition from nonbank lenders or a lack of confidence at companies due to political upheaval.

The exact reason demand for business loans has risen of late is tough to pinpoint. Many analysts point to metrics that show businesses have a rosier economic outlook. Some bankers think midsize clients are laying plans to expand, including through acquisitions, and are drawing on lines of credit to fund those endeavors, according to a federal advisory council of bank executives.

“Businesses no longer have an excuse not to borrow. Whether it was the election, deregulation or taxes—now we have the answer to all three,” said Chris Marinac, director of research at FIG Partners LLC. “They have every reason in the world to take on debt and expand.”

Business loans are growing faster at small and midsize banks than they are at the biggest U.S. lenders, according to Fed data. These smaller lenders tend to focus on businesses outside of the largest corporate firms.

At Green Bay, Wis.-based Associated Banc-Corp , clients started to seem more interested in borrowing last year as the tax overhaul took shape, said David Prince, executive vice president for commercial banking. Now, they are taking out loans, driven by both a bullish economic view and a desire to borrow before rates rise much further, he said.

Stronger business-loan growth is helping lift broader lending growth. Overall loan growth at banks increased to a 5% year-over-year growth rate in late June from 3.9% at the start of 2018, according to Fed data. Growth in some other categories of lending, such as for commercial real-estate projects like apartment buildings, by contrast, is slowing.

Accelerating loan growth could pressure some banks to raise deposits to fund loans, although most banks still have loan-to-deposit ratios that are low enough to provide them with lending headroom.

That is fortunate because while deposits are still growing across the industry, they are doing so at a slower pace than in recent years. And the three largest national lenders, JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co., continue to garner much of the growth in deposits.

That is causing some smaller banks to pay higher interest rates to attract more deposits. The downside is this can eat into the profit margin on loans, cutting some of the benefit of increased volume growth.

There also are concerns that banks, eager for growth, are making business loans with looser terms that may lead to problems in the future.

In a May report, the Office of the Comptroller of the Currency, or OCC, identified the easing of commercial-loan standards as a top risk in the banking industry. While the rate of bad business loans remains low, and most banks still have a moderate risk appetite, the regulator said that during the past year it privately issued more warnings ordering financial institutions to modify their business-lending practices.

The OCC said banks are extending interest-only periods on commercial loans, allowing borrowers to draw down bigger portions of the value of collateral and relaxing covenants meant to protect from losses.

One big concern: While rising rates will make the loans more lucrative for banks, they may make it harder for businesses to pay off the loans, the OCC said.

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