Continued Growth Despite Growing Headwinds: What 1Q2022 Showed Us in Commercial Lending

Coming out of 2021, when there were signs that the economy and commercial lending were on the rebound, we continued to see growth in the first quarter of 2022, despite some growing headwinds. But a look at the broader market and economic forces shaping 1Q2022 commercial lending trends show that there are forces, including the Fed’s first rate hike in three years and excess liquidity in the banking system, that may temper the benefit that banks realize and slow any rebound.

What the Leading Economic Indicators are Telling Us
Coming into the first quarter, the economy was heating up, with C&I loan growth accelerating; however, since that time the impact of the Omicron COVID-19 variant on the overall economic rebound has started to show. But what are the four variables central to commercial lending demand—Gross Domestic Product (GDP), Consumer Price Index (CPI), unemployment rates, and the Business Confidence Index (BCI)—showing in terms of potential future growth?

Sources:
U.S. Bureau of Economic Analysis
U.S. Bureau of Labor Statistics
Business Tendency and Consumer Opinions Surveys

Challenges Present Themselves
Real GDP—a leading indicator for C&I loan growth—was negative for the first quarter of 2022 (attributable primarily to restrictions and disruptions caused by the Omicron COVID-19 variant), ending the expansion we have seen for the last year and a half.

But what is becoming a bigger headwind for loan growth is inflation. As the chart below shows, the year-over-year change in the CPI remains well above historical norms, even when excluding food and energy prices. The high inflation numbers prompted the Fed to raise short-term interest rates in mid-March, and then again in early May, the largest rate increase since May 2000. The challenge here, for the Fed and FIs, is the danger that interest rate increases could hinder economic growth and dissuade borrowers from taking out new loans. Source: AFS Pricing Database

Markets rates, specifically, show their sensitivity to the Fed’s rate hikes. Average interest rates on new/renewed C&I and CRE loans increased in the weeks leading up to the Fed’s rate hike in March. While further Fed tightening is anticipated, excess liquidity in the banking industry, coupled with competition from non-bank lenders, may limit the benefit banks experience in the form of higher loan yields.

Positive Indicators Remain
Even though GDP and CPI may indicate challenges ahead, in terms of commercial loan growth, U.S. employment rates and Business Confidence Index were positive indicators in this area.

While the odds of a medium-term recession have increased, the U.S. unemployment rate point to a labor market that is still quite strong, maintaining pretty much full employment with the unemployment rate trending at 3.6% at the end of the first quarter. And even though it took a hit due to the fallout of Omicron and the Russia/Ukraine conflict, business confidence remained above the long-term average, providing the necessary demand for commercial loan growth, as we saw throughout 1Q2022. Source: Federal Reserve H.7 Data Release

Looking at loan growth at the end of the quarter, we find that despite some of the recent headwinds to the economy mentioned above, commercial lending managed to post an increase in March. Total C&I and CRE balance growth was stronger than expected, with broad-based increases across geographic regions, and the acceleration of the new deal flow continued, supporting previous bank guidance of strong loan pipelines.

The Future is Hazy
With more interest rate increases, the competition for the best loan customers and loan growth becomes even more a priority for FIs, and excess liquidity still looming, forecasting loan growth over the next year is a difficult exercise. Additionally inflation continues to soar and the prospect for an economic recession looms should the Fed tighten too aggressively; but for now, the labor market is strong, problem loans remain low, and commercial loans are growing.
 
About the Data
Information is pulled from the AFS Pricing Service database, an independently verified robust database considered the industry source for commercial lending trends. The information shared here and more was also discussed in the recent complimentary AFS webinar, “Pricing Fundamentals, a Review of the 1Q2022 Commercial Lending Landscape.” Stay on top of important commercial lending pricing trends with the industry renowned Commercial Loan Pricing Newsletter. Sign up to receive the newsletter, information on webinars, and more insights from AFS!