Credit conditions expected to remain poor this year, bank economists say

The American Bankers Association’s headline credit index came in more than almost 43 points below the 50-point threshold that marks the line between improving and deteriorating credit conditions.

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Bank economists predict that lenders will remain quite cautious in the coming six months amid soaring interest rates and ongoing worries over the economic outlook.

The American Bankers Association’s headline credit index, which measures sentiment about both consumer lending and commercial lending, remained near an all-time low despite a slight improvement in the most recent quarter.

The index, which is based on a survey of chief economists at 15 of the nation’s largest banks, came in more than almost 43 points below the 50-point threshold that marks the line between improving and deteriorating credit conditions.

The economists expressed greater pessimism about business credit availability than consumer credit availability, but they expect both to keep worsening. 

The consumer credit index rose by 2.6 points in the third quarter to 8.3, but none of the surveyed economists expected consumer credit quality and availability to improve later this year. The business credit index ticked up by 0.5 points but remained quite low at 6.3. 

Bank credit availability has been strong over the past few years, but the Federal Reserve’s rate hikes over the past 15 months have contributed to lower demand for credit. 

The recent turmoil in the banking industry has also led banks to adopt tighter lending standards. That has been especially true among midsize banks, which have expressed more concern about liquidity and funding costs. 

“This is more or less in the context of what was expected to be a challenging economy,” said Richard Moody, who is the chief economist at Regions Financial and was one of the economists surveyed by the ABA. “We’re all this kind of bracing for some normalization — getting back to where we were prior to the pandemic.”

Tighter lending standards are generally expected to follow worsening credit market conditions, but household financial household conditions remain healthy, and delinquency rates are still relatively low.

During the first quarter of 2023, delinquency rates on credit cards and auto loans ticked up, according to the Federal Reserve Bank of New York’s quarterly report on household debt and credit in May. But those numbers had previously been near historic lows.

Consumers still appear capable of meeting their debt obligations. Debt made up roughly 5% of disposable income in the first quarter, more than three-tenths of a percentage point below pre-pandemic levels, according to the ABA report. 

Businesses also appear prepared to manage their debt. Commercial and industrial loan delinquencies fell to a near-historic low of below 1% in the first quarter, while charge-off rates rose slightly but remained below pre-pandemic levels, according to the ABA report.

But with slower growth now expected, businesses may need to grapple with weakened consumer demand and fewer prospects for investment, which figures to hurt commercial loan demand.

Banks have also begun to tighten their standards.

In the Federal Reserve’s most recent senior loan officer survey, the net percentage of banks that raised standards for commercial and industrial loans was 46%. That survey, conducted between late March and early April, included responses from 84 banks.

Similar to the ABA’s findings, the Fed’s survey of bankers showed that the industry expects further tightening across all loan categories for the remainder of the year.

“Banks are going to be really mindful of what’s happening in a particular market,” said ABA Chief Economist Sayee Srinivasan.

Starting in 2022, the Fed hiked interest rates several times to counter rising inflation. On Wednesday, it held its key interest rate steady –– at roughly 5% –– for the first time in more than a year.

“Even if rates don’t change, the cumulative effect of everything that the Fed has done will slow economic activity,” Srinivasan said.

The U.S. job market has remained strong, with the unemployment rate increasing only slightly in May to 3.7%, according to the U.S. Bureau of Labor Statistics. Meanwhile, wages have risen roughly 4% over the past year, with pay growth highest among lower-wage workers.

Maintaining a strong labor market will be critical to how loan demand and credit quality evolve as lenders become more guarded, Srinivasan said.

“If the labor market remains strong, that means people will be spending, so demand will remain strong,” he said. “Even if households continue to borrow money… they will continue to make payments on their loans. Credit quality will remain good.”

Srinivasan said that Wall Street appears to be betting on a soft landing for the U.S. economy, but he noted that there has been a recent uptick in unemployment and a downtick in gross domestic product.

“The question is: How bad is it going to be?” Srinivasan said.

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