The second quarter of 2022 was notable for median loan growth in the Twelfth District. The headline number—16% year-over-year, excluding PPP loans—was the fastest pace since 2006. So, why the sudden acceleration in growth? Is this a sign of an economic recovery, and how do bankers feel about growth moving forward in this age of rising interest rates?
A favorable shift in asset mix
Banks funded this loan growth primarily with on-balance sheet liquidity they had at the ready. Twelfth District banks had a lot of cash built up due to a surge in deposits during the height of the pandemic. They then used that cash on hand to fund loans—causing a shift in asset mix towards loans and away from short-term, liquid assets.
Importantly, this shift in asset mix, along with rising interest rates, benefitted earnings, since loans tend to be higher yielding than other types of assets held by banks.
The Twelfth District led all other districts in loan growth with the highest median rate. Demand for loans might differ by region because local economies have been recovering at different speeds. Places like Salt Lake City, Boise, and Phoenix have been growing rapidly, driving the demand for commercial real estate (CRE), which includes construction and land development.And the data in our First Glance 12L report demonstrates this. District bank loan portfolios continued to center in CRE categories, including those backed by owner-occupied (OO) and nonowner occupied (NOO) collateral. At 222% in the second quarter, the District’s median NOO CRE concentration ratio greatly exceeded the national median of 124%.
Downside risks
The downside of the loan growth is twofold. First, on-balance sheet liquidity came down, meaning that banks don’t have the same volume of liquid instruments on hand to fund further growth. If they want to grow loans further, they may need to raise funds in other ways by ramping up deposits, borrowing money from sources like the Federal Home Loan Bank, or raising capital. As a result, competition is heating up on the deposit and the lending sides. The second downside has to do with risk-based capital ratios, a regulatory measure used to assess capital adequacy. The denominators of these ratios risk weight various components of the balance sheet based primarily on credit risk features. Cash and fixed income securities generally carry lower risk weights than most loan categories. So, the shift in balance sheet mix tended to increase risk weighted assets and reduce risk-based capital ratios, all else equal.
As we’ve discussed, lending momentum proved strong in the first half of 2022. But steps taken by the Federal Reserve to combat inflation could prompt a slowdown. In the Fed’s Senior Loan Officer Opinion Survey, more than a third of loan officers said they would tighten lending standards for Commercial and Industrial (C&I) and non-conforming jumbo loans in the second half of 2022. Furthermore, the survey found that inflation was top of mind for survey respondents: “the most cited reasons for expecting to tighten standards over the second half of 2022, all cited by major net shares of banks, were an expected deterioration in borrowers’ debt-servicing capacity due to higher inflation or inflation risk, an expected deterioration in collateral values, an expected deterioration in the credit quality of loan portfolios, an expected reduction in risk tolerance, and an expected increase in the exposure to interest rate risk due to higher inflation or inflation risk.”
Other third-party surveys suggest increasing caution on the part of bankers when it comes to future loan growth. A late-June survey of community bank executives by IntraFi Network found that 48% of bankers in the West expected loan demand to soften in the coming year, up from 26% who felt similarly in April.
For more details on economic and banking conditions across the District, visit the full First Glance 12L 2Q22 report.
You may also like:
Charting New Stories with SF Fed Data Explorer
Community Conditions: A New Section in the SF Fed’s Beige Book Report
How Do Homeowner Experiences Vary by Race and Ethnicity? Neighborhood Differences between Hispanic and White Homebuyers
The views expressed here do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.
Elizabeth Lawson-Kurdy is the communications lead for Supervision + Crediton the Communications + Experience team the at the Federal Reserve Bank of San Francisco.
Loan Growth Accelerates as Bankers Note Caution for Rest of 2022. The second quarter of 2022 was notable for median loan growth in the Twelfth District. The headline number—16% year-over-year, excluding PPP loans—was the fastest pace since 2006.
Banks tightened the criteria used to approve loans over the past year. Analysis shows that their tighter lending standards can be partially explained by economic conditions that reduce demand for loans and increase their potential risk, such as policy rate increases and a slowing economy.
Federal Reserve lending to depository institutions (the "discount window") plays an important role in supporting the liquidity and stability of the banking system and the effective implementation of monetary policy.
Higher interest rates have boosted banks' net interest income—resulting in higher net interest margins (NIMs) and enhanced profitability. Lenders have benefited from a widening of the spread between the interest they pay to depositors, and the income they reap on lending.
Although banks do many things, their primary role is to take in funds—called deposits—from those with money, pool them, and lend them to those who need funds. Banks are intermediaries between depositors (who lend money to the bank) and borrowers (to whom the bank lends money).
Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan.
Higher interest rates prompted banks to restrict lending. In a Fed survey last summer, many banks said they had tightened lending standards. Almost no banks said they had made borrowing easier. Some banks continue to tighten credit standards in 2024, according to the latest Fed survey, taken in January.
The Fed continues to place currency orders because people and businesses still want actual cash and see it as proof of the availability of funds. The government understands that printed currency allows for, and encourages, ongoing commercial transactions.
The Federal Reserve System is not "owned" by anyone. The Federal Reserve was created in 1913 by the Federal Reserve Act to serve as the nation's central bank. The Board of Governors in Washington, D.C., is an agency of the federal government and reports to and is directly accountable to the Congress.
Besides loans, banks also invest in bonds and other debt securities, which lose value when interest rates rise. Banks may be forced to sell these at a loss if faced with sudden deposit withdrawals or other funding pressures.
Heightened interest rates have already led to the most stringent credit standards and weakest loan demand from consumers and businesses in a long time in the US. Meanwhile, banks are dealing with other major challenges such as the plunge in demand for office space as a result of home working.
Banks do not hold 100 percent reserves because it is more profitable to use the reserves to make loans, which earn interest, instead of leaving the money as reserves, which earn no interest.
“When a depositor makes a deposit, the funds become the property of the bank, and, in exchange, the depositor receives a claim against the bank for the amount of the deposit.”
Banks create money when they lend the rest of the money depositors give them. This money can be used to purchase goods and services and can find its way back into the banking system as a deposit in another bank, which then can lend a fraction of it.
Banks report tightened lending standards for nearly all residential mortgages: Fed survey. Banks reported having tightened lending standards across almost all categories of residential real estate loans over the fourth quarter of 2023 amid an elevated interest rate environment. There's some optimism, however.
After significantly tightening the stance of monetary policy since early 2022, the FOMC has maintained the target range for the policy rate at 5-1/4 to 5-1/2 percent since its meeting last July.
A legal lending limit is the most a bank or thrift can lend to a single borrower. The legal limit for national banks is 15% of the bank's capital. If the loan is secured by readily marketable securities, the limit is raised by 10 percentage points, bringing the total to 25%.
Tightening policy occurs when central banks raise the federal funds rate, and easing occurs when central banks lower the federal funds rate. In a tightening monetary policy environment, a reduction in the money supply is a factor that can significantly help to slow or keep the domestic currency from inflation.
Hobby: Calligraphy, Rowing, Vacation, Geocaching, Web surfing, Electronics, Electronics
Introduction: My name is Msgr. Benton Quitzon, I am a comfortable, charming, thankful, happy, adventurous, handsome, precious person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.