Fitch: U.S. Bank Loan Growth Driven by Smaller Institutions

Smaller U.S. banks appear to have been more aggressive lenders over the last twelve months and may be more vulnerable to asset quality deterioration in a rising rate environment, according to Fitch Ratings. Loan growth trends among larger and smaller U.S. banks noticeably diverged in 2013. Loan books were broadly stable at the 25 largest institutions in 2013 while the small banks group grew loans by 4.8%, according to recently released Fed data.

We believe smaller banks have been particularly aggressive with commercial and industrial (C&I) loans, which saw growth exceed 8% in 2013, or almost one third of the $115 billion loan book growth for small banks.

Signs of overheating continue in bank C&I lending. Fed officer surveys have pointed toward more lax standards and pricing on these loans, as did this year's interagency loan review of shared national credits. Furthermore, we primarily see smaller banks as price-takers and term-takers and likely to accept weaker loan covenants. However, we believe some Top 25 banks could also be sacrificing loan pricing. Unlike the smaller banks, the larger banks typically offer multiple services to their customers that compensate for the competitive pricing. We do not envisage direct rating implications for most banks at this time from near-term C&I performance.

Real estate loan growth of 4% for smaller banks was primarily paced by expansion in commercial real estate lending, which was up over 6% year-over-year (yoy) for the group. While not broken out in the weekly aggregate Fed data, we believe that smaller banks have increased their holdings of loans secured by multifamily and office properties. These may be more exposed to rising interest rates, especially if low hurdle rates were used for underwriting. The group's level of closed-end residential loans bumped up over the past year (at just 2%), potentially pointing toward smaller banks' willingness to extend on-balance-sheet duration to stave off near term margin compression.

Consumer loans also expanded in 2013 even with the continued deleveraging of U.S. consumers. The aggregate Fed data shows a net yoy decline in credit card outstandings on both groups' balance sheets. However, growth of 5% and 11% for the large bank and small bank group respectively in "other consumer loans" more than outpaced the shrinkage of card balances. This loan category is primarily made up student and auto loans. Fitch believes the auto loan space has also experienced loosening underwriting standards over the past year.

The top 25 banks saw a shift away from real estate lending and into C&I and other loans, but no net increase in overall loan book in 2013. This could be for a variety of reasons, including increased regulatory scrutiny over consumer loan products as well as the need to wind down sizable legacy portfolios.

In aggregate, U.S. bank loan growth in 2013 was muted at 1.9%, down from around 4.5% in 2012, but in line our 2013 GDP expectation of 1.7%. Fitch expects loan demand to stay muted against the backdrop of modest GDP growth. This highlights the challenges for revenue growth in the weak economic recovery, particularly as mortgage refinancings have dropped with the pickup in long-term rates in May 2013. Banks are likely to focus primarily on levers they can control, such as expenses, to offset net income pressures.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

Applicable Criteria and Related Research:

2014 Outlook: U.S. Banks

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=723989

U.S. Banking Quarterly Review: 3Q13 (Revenue Growth Still a Challenge, Reserve Releases Buoy Earnings)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724883

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