Markets are optimistic that the Federal Reserve will achieve a "soft landing," but recent softness in commercial lending trends raises the risk that the country will slip into a recession, according to economists and analysts.
Bank lending to commercial clients — businesses big and small — has fallen from January highs as companies' wariness over the economic outlook persists. The outlook for loan growth isn't particularly strong either, thanks to a combination of reduced demand from commercial clients and tighter standards from banks.
That mix can damage the economy as businesses slow their expansions, hire fewer people and ultimately set off dominoes that will result in layoffs. The U.S. economy has proved to be surprisingly resilient over the past year, but the slowdown in commercial borrowing will be the latest test.
"This actually points to a deep recession, yet we're not actually seeing it on the surface yet," said Derek Tang, an economist and the CEO of Monetary Policy Analytics. "This is what is making everyone a little bit nervous."
Banks have been rapidly tightening their underwriting standards over the past year, according to a Fed survey of senior loan officers at banks. They're raising the bar for commercial borrowers seeking loans, turning more often to only those borrowers whose profits can deliver. And banks are charging higher interest rates to make up for what they see as a slightly riskier environment.
Those steps are a "credit positive" for individual banks, as they appear to be "getting ahead of the curve" and avoiding future losses by taking less risk, said Allen Tischler, senior vice president at the ratings firm Moody's Investors Service. But the combined effects of businesses having a harder time getting credit can lead to pain later.
"That might not impact employment negatively tomorrow, or the following week, or the following month," Tischler said. "But at some point, you would see it show up in employment."
So far, the job market remains mostly solid, with employers adding 187,000 jobs last month and the unemployment rate at 3.5%. The economy's resilience has made some analysts less gloomy. Goldman Sachs
Credit quality remains benign among banks' commercial clients, which are staying current on their loan payments even with interest rates at 22-year highs. Some sectors like
The rate of commercial and industrial loan net charge-offs across the industry was just 0.26% in the first quarter, compared with an average of 0.84% since 1984, according to Truist Securities analyst Brandon King, who focuses on regional and community banks.
But the risk of those figures climbing "remains overlooked" compared with investors' constant worries over commercial real estate, King wrote in a note to clients. Credit conditions haven't been this tight since the start of the pandemic, when the government minimized loan losses by flooding consumers and businesses with cash, he wrote.
That level of help is unlikely this time around, and charge-off rates could hit 1% if the U.S. economy slips into a recession, King wrote. Such distress would not be as severe as during prior recessions, but the tougher outlook means that banks may soon have to set aside more money to cover potential losses, he added.
Commercial bankers acknowledge that some indicators are trending negative, but say they're cautiously optimistic — and still open for business even as they tighten around the margins.
Mary Katherine DuBose, the head of Wells Fargo Credit Solutions at the company's commercial bank, said in an interview that her team still has "great appetite to lend to quality borrowers." The team is also running analyses to ensure that its portfolio stays in good shape no matter what comes next, DuBose said.
"We are building in more aggressive rate shocks and rate analysis and cash-flow analysis to make sure that borrowers can absorb that, as well as … weaker margins because that's a theme and a trend that we're seeing," she added.
Stephanie Novosel, head of commercial banking at PNC Financial Services Group, said the $558 billion-asset bank is also not seeing much "stress and strain" in its portfolio. She said some clients are in a "wait-and-see" mode as they wait for the economic outlook to clear up.
And rather than borrowing, some business customers are using the cash they built up in recent years to pay for their expansions, Novosel said.
Companies are "doing the math" and opting against saddling themselves with loans that carry rates of 7% or higher, Truist's King said. Since that cash is coming out of banks' deposit coffers, the outflows are a headache for smaller regional banks that are
The more tepid pace of loan growth — a mix of borrower and lender caution — lines up with broader signs that the U.S. economy may grow by less than 1% in the coming quarters, said Richard Moody, chief economist at Regions Financial.
Even if the country ultimately steers clear of a recession, the coming months may still feel a bit like one.
"The outlook is for a period of very slow growth," Moody said.
And that, ultimately, may be a good enough outcome for the Fed, said Danielle Marceau, a principal economist at the data and forecasting firm Prevedere. The central bank has sought to raise rates "just enough to cool the economy" without completely choking off growth.
"If banks become more conservative, if they continue to tighten their lending standards, if they reduce loan availability a little bit, that can help curb that spending, which is exactly what the Fed needs to navigate a soft landing," Marceau said.
