JUNE INVESTOR NEWSLETTER – Anfield’s Promontory

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A Nation of… Savers??

Just as the economy seemed ready to snap out of its deflationary haze, it seems the once-spendthrift American consumer has gone skinflint. In the first quarter of the year, as reported by the Federal Deposit Insurance Corporation, loan balances declined by 0.1 percent on a quarterly basis, the first such contraction since 2013. According to the Federal Reserve Bank, credit creation is evaporating across a broad spectrum of consumer and commercial sectors, from automobiles and commercial real estate to the all-important C&I, or commercial and industrial space.

The Fed attributes the winnowing of new loans after four years of solid growth to historically weak demand from consumers – whose purchasing power account for 70 percent of GDP – and tightened lending standards on the banking side. (I might suggest stagnate wages also play a role; according to the most recent data published by the monthly Current Population Survey, median annual household income surpassed its January 2000 level for the first time since the survey was launched.)

Largely as a result, banking stocks have lagged other corporate sectors in the post-election equity stampede, and the prospect of continued rate-tightening represents a compelling threat to loan formation and, ultimately, economic growth. As blogger Richard J. Parsons wrote last month, “if bank lending does not turn around, investors need to not only question the health of bank stocks but the overall economy.”

The numbers reveal a sobering picture of credit lock-down in the developed world’s largest and most sophisticated banking system. According to the data, large corporations’ and mid-market companies’ demand for loans stalled out as we moved through 2016. Demand for C&I loans, which account for 21 percent of total bank credit, have been trundling along in negative territory since late last year. “The declining demand for businesses loans” warned the ZeroHedge blog last month, “is by far the most concerning aspect of an economy that is supposedly growing, and where companies should be willing to take out new credit to fund expansion.”

In a trend that has profound implications for the automobile industry, for example, car-loan creation has fallen by 50 percent since last September, when Ford CEO Mark Fields declared that auto sales had peaked. Since February, the share prices of leading car-finance companies Ally and Capital One have taken a beating. Just this week, the Financial Times reported that large banks are pulling back from auto-lending – a $1.2 trillion market – amid fears that consumers have taken on more debt than they can handle.

Another stark indication that consumers are in retreat: demand for credit cards have slipped to their lowest quarterly level in years, according to the Fed’s Senior Loan Officer Survey, despite “visibly softer” underwriting standards and stylish cards – American Express’s Plum, for example, or Master Card’s 24-Karat coated offering – designed to tempt consumers back into the market. It is hard not to associate this emerging debt-phobia with the wasting away of the nation’s brick-and-mortar retail chains.

At the same time, banks like Ally and Capital One as well as commercial real estate lenders – the majority of which are small community banks – are tightening lending standards in response to deteriorating loan quality. Data released this week revealed the first sequential drop in outstanding car loans written by commercial banks in at least six years – from $1.6 billion to $440 billion in the fourth quarter of last year – suggesting lenders are worried about rising delinquencies and the prospect of litigation.

The banks are right to be skittish. Credit card default rates have surged to their highest levels since June 2013 – a trend that, when superimposed upon tightened lending standards and the rationing of credit that such activity implies, suggests a consumer-debt famine of indeterminate length. As ZeroHedge points out, loan growth is among the most reliable metrics in the dismal science. And every time C&I growth peaks, recession follows.

A peculiar feature of the current economic landscape is the positive sentiment registered by consumers and business leaders in vivid contrast with the actual data, which is uninspiring to say the least. Truth be told, we at Anfield share their optimism – assuming, of course, it will eventually convert itself into action. We are aware that a debt retrenchment would be welcomed under normal conditions. After all, the magnitude of public, corporate and household debt is off the charts and is in need of consolidation. In addition, banking-sector investors may rest easy knowing that creditors are increasingly judicious when parsing through loan applications and business plans. As Parsons wrote dryly in his blog: “The best time to tighten credit standards is before it’s obvious that it’s time to tighten credit standards.”

But these are not normal times – or if you prefer, we’re back to normal now that the post-war economic boom has run its course – and we need all the help we can get. Even the White House has acknowledged that its vaunted 3.0-percent growth estimate is most likely beyond reach. If the era of reflation is to survive, healthy loan growth must be restored. Perhaps the best way to do that is to create wealth by investing heavily in our nation’s neglected infrastructure, even at the cost of still more debt – and soon, while the dollar is still the world’s reserve currency.

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