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Is The Economy Signaling A Sustainable Recovery?

Bank Lending, Lending Standards, And GDP Growth

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Patricks SimsMarshall Schraibman

Findings:

U.S. commercial bank

loan growth tells uslittle about currentor uture economicgrowth, as its a lag-ging indicator

Lending standardsare historically bet-ter at measuring the

health o the econo-my and orecastingeconomic growth

Recent trends in U.S.household debt re-lect more judiciouslenders and borrow-ers

The U.S. economy hasbeen looking for greenshoots since the crisis end-ed, but has been gettingmixed messages in re-sponse. GDP growth in thefirst quarter of 2014 came inat negative 2.1 percent, onlyto bounce back to 3.9 per-cent in the second quarter.Many question where theeconomy actually sits today,and whether we can sus-tain growth into the future.

One place to look for someanswers may be the banklending that supports muchof our economic activity.

Also in the second quar-ter, U.S. commercial banklending hit a new high. Welooked to see if we could usethat information to give us acurrent economic snapshot,

and possibly predict futuregrowth. Surprisingly, loangrowth tells us little aboutcurrent or future economicgrowth, based on our analy-sis.

While companies and peo-ple take out loans to expandproduction, build a house,

and hire people, on the mac-ro level, our analysis showsbank lending is not a lead-ing indicator, but a laggingone. Instead, when thinkingabout broader growth, lend-ing standards are better atshowing where the econo-my currently sits, and whereits possibly going.

The following analysis looksat the correlations betweenthe U.S. commercial bank

lending growth, change inlending standards per theFeds Senior Loan OfficerSurvey, and GDP growth.

Bank Lending Lags

Statistical analysis of banklending and GDP growthreveals that bank lendingis a lagging indicator. The

highest correlation betweenthe two indicators occurredbetween GDP growth

t=0and

bank lendingt=3

(R=.46; p=2*10-06)(Figure 1). All else equal,bank lending in future quar-ters should reflect todaysGDP numbers.

Bank lending growth came

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and large firms, recentlyupdated at the end of July.The survey of lending stan-dards is based on input from75 large domestic banks and

branches of foreign banks.

According to the Fed, therecent survey showed acontinued easing of lend-ing standards and terms formany types of loan cate-gories amid a broad-based

2Hamilton Place Strategies

in at 8.4 percent in the sec-ond quarter of 2014, whileGDP growth came in at 3.9percent. While the latestdata on bank lending maynot forecast GDP growth,based on historical data, itcould mean that the frosty

GDP growth in the first quar-ter of 2014 coming in atnegative 2.1 percent wasprobably more due to thedisruptive effects of weath-er than overall health of theeconomy, as many econo-mists predicted.

Lending Standards Lead

We get different resultswhen looking at the FedsSenior Loan Officer Opin-ion Survey on Bank LendingPractices for small, medium,

pickup in loan demand.

Our analysis reveals that thenet change in respondentstightening standards wasfar more predictive of futureeconomic growth (Figure 2).

The highest predictive pow-er was actually in the sameperiod (R=.54; p=8.86*10-09).However, the data is stillstatistically significant whenlending standards leadeconomic growth (R=.52;p=7.37*10-08). All else equal, fu-ture GDP growth may reflecttodays lending standards.

Our analysis largely reflectsthe findings from a NewYork Fed study from 2000.Their analysis found thatlending standards, as mea-

Our analysis reveals

that the net changein respondents tight-ening standards wasar more predictiveo uture economicgrowth.

Fig. 1: U.S. Real GDP Growth and U.S. Commercial Bank Loan Growth (%)

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-15

-10

-5

0

5

10

15

20

-10

-5

0

5

10

06/14

06/09

Annualized

QoQ

LoanGrowth(%)

06/12

06/11

06/06

06/07

06/10

06/13

06/08

AnnualizedQoQ

GDP

Growth(%)

06/05

GDP Growth (%)Loan Growth (%)

Loan growthhistorically lags

GDP by 3 quarters

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3Hamilton Place Strategies

sured through the samesurvey data during the 1990s,

show that standards helpconsiderably in predictingGDP growth.1

Risks With Easing

While easing lending stan-dards certainly increases theamount of risk in the system,the latest lending surveydoes not necessarily mean

that current levels are dan-gerous. The financial crisiswas largely triggered byextremely lax lending stan-dards for home mortgages,among other factors.

That said, the latest surveyreveals that a large amountof respondents indicated

that recent mortgage reg-ulations were lowering

their approval rates on suchloans, and that more

than half of the respondentsindicated that the ATR/QMrule has reduced approv-al rates on applications forprime jumbo home-pur-chase loans.2

The Wall Street Journals Nick

Timiraos quotes Janet Yellenmaking a similar point. Ac-

cording to Yellen, only themost pristine borrowersare able to secure mortgag-es.4

Basically, dont look for thehousing sector to lead therecovery any time soon.

After falling for several yearshousehold debt levels rose

in 2013, but then fell again inthe recent quarter becauseof low mortgage origina-tions,3based on data fromthe New York Fed (Figure 3).

The trends, according tothe WSJs Alan Zibel, sug-gest Americans continue torecover from the recession

Our analysis revealsthat the net changein respondents tight-ening standards wasar more predictiveo uture economicgrowth.

Fig. 2: U.S. Real GDP Growth and Lending Standards For Small, Medium And

Large Firms

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0

20

40

60

80

100

-10

-5

0

5

10

15

20

25

06/05

06/06

RealGDPGrowth

(%)

06/14

06/12

06/13

06/10

06/11

06/09

06/08

06/07

Net

%O

fRespondents

TighteningStandards

Tightening Standards For Medium & Large Firms (%)

Real GDP Growth (%)

Tightening Standards For Small Firms (%)

Lending standardsare an inverseindicator of growth

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Hamilton Place Strategies 4

Footnotes1 Lown, Morgan, And Rohatgi, Listening To Loan Officers: The Impact Of Commercial CreditStandards On Lending And Output, FRBNY Economic Policy Review, July 20002 Board Of Governors Of The Federal Reserve System, July 2014 Senior Loan Officer Opin-

ion Survey On Bank Lending Practices, Senior Loan Officer Opinion Survey On Bank Lend-ing Practices, August 4 20143 Haughwout et al, Just Released: Looking under the Hood of the Subprime Auto LendingMarket, Liberty Street Economics, August 14 20144 Timiraos, Fed Survey: Mortgage Standards Ease for First Time Since Housing Bust, WallStreet Journal, August 4 20145 Zibel, Americans Borrow for Cars, Less So for Homes, Wall Street Journal, August 14 2014

by paring existing debt andtaking on new loans judi-ciously.5

Time will tell if current eas-ing of lending standardswill lead to future economic

growth. Although historically,its a good bet.

Methodology

This analysis relies on dataobtained from the Federal

Fig. 3: Improvement In Household Debt And Delinquency

8

9

10

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12

13

14

3.0

4.5

6.0

7.5

9.0

10.5

12.0

06/05

06/06

06/07

06/11

06/09

06/08

06/12

Delinq

uentHouseholdDebt(%

)

TotalHousehold

Debt($T)

06/10

06/13

06/14

Percent Of Household Debt 30 Or More Days Past Due (%)

Total Household Debt ($T)

Reserve Bank of St. Louis andthe Federal Reserve Bank ofNew York. It reflects season-ality and inflation adjust-ments where possible. []