Credit tightened in 4Q — but lenders are more upbeat about 2024

U.S. bankers upped their standards once again late last year as they braced for credit quality to deteriorate in 2024. This played out across all commercial and consumer loan segments.

At the same time, the Federal Reserve's latest quarterly survey of senior loan officers across the country found that the pace of tightening eased from prior reports and expectations for stronger loan demand increased for the year ahead. The results were issued last week based on feedback obtained in January.

"While the survey overall pointed to weaker demand and tighter standards across the board, we are focused on the rates of change. And here, we were glad to see that the results in both demand and standards were not as bad as in the [October survey's] results," Piper Sandler analyst Scott Siefers said.

Bankers also "noted their hopes that demand would improve across all categories as the year plays out," creating "some rays of hope in the results that are consistent" with a second half of 2024 "rebound story many banks are now telling," he added.

To be sure, bankers said stubbornly high interest rates — following multiple Fed hikes over the past two years to curb inflation — made it difficult for more borrowers to qualify for loans. Demand continued to be weak as a result, and banks were also increasingly selective with the loans they made.

In its latest inflation data on Tuesday, the U.S. Labor Department said its consumer price index increased at a 3.1% annual pace in January. That was down from four-decade highs that exceeded 9% in 2022 and from 3.4% at the close of 2023. But it was still well above the 2% rate that the Fed targets as healthy for the economy. This could discourage a rate cut at policymakers' next meeting in March and kick such a decision to the following Fed gathering in May or beyond.

"Lowering interest rates means that lending will increase, and thus the U.S. economy will probably grow at a higher rate, which could put further upward pressure on prices or at least not allow prices to get to the 2% target rate," said Raymond James Chief Economist Eugenio Alemán.

As such, he said, rates could remain elevated for longer.

All of this helps to explain why many banks reported slower or no loan growth in the fourth quarter when compared with the prior quarter and a year earlier. When lending activity slows, banks' bread-and-butter interest income eases in tandem, adversely affecting profits.

For example, of the 58 banks with total assets of $10 billion and $100 billion that reported fourth-quarter results between Jan. 22 and Jan. 26, 41 posted lower earnings per share relative to the prior quarter and the year-earlier period, S&P Global Market Intelligence data show.

Higher deposit costs — another direct tie to the high-rate environment — and increased credit expenses in the forms of loan charge-offs and loss provisions also hindered earnings for many, according to S&P Global.

For commercial borrowers, the latest Fed survey data suggests "businesses remain very cautious and are reluctant to put money to work right now," said James Knightley, ING's chief international economist.

The Fed report emphasized "decreased customer investment in plant or equipment and decreased financing needs for inventories, accounts receivable, and mergers or acquisitions."

Knightley noted the Commerce Department reported that the U.S. economy grew through both the third and fourth quarters, bolstered by a strong job market. Employers added jobs every month last year and started 2024 by creating another 353,000 positions, the best result in a year, according to the Labor Department. The unemployment rate held steady at 3.7% for a third consecutive month, well below the past 35-year median jobless rate of 5.4%. All of that provided a boost for consumers, many of whom were also empowered by pandemic-era government aid that helped to fortify savings.

But signs of vulnerability loom.

"High borrowing costs and tight lending conditions proved to be no obstruction to the U.S. economy powering ahead strongly through the second half of 2023. Nonetheless, that was when we still had abundant savings accrued through the pandemic that we could put to use," Knightley said. "There is more and more evidence that much of this has been exhausted and this story is likely to be less supportive for the economy in 2024."

Rising credit card debt and delinquencies represent key elements of that evidence. An S&P Global analysis of the average annualized net charge-off rate for the six largest U.S. credit card issuers in December rose 88 basis points from a year earlier to 2.08%, its highest level since reaching 2.21% in August 2020.

Such signs of deterioration also are pushing bankers to grow increasingly choosy with consumer loans. This could weigh on gross domestic product growth, by extension, given the U.S. economy is driven by consumer spending. A weaker economy historically has proven a catalyst for higher credit losses overall.

"Bank lending may well turn negative in year-over-year percentage terms through the middle of the year before starting to improve towards the end of 2024," Knightley said.

Why the eventual improvement? Knightley said this outlook largely hinges on expected interest rate cuts this year. Should consumer spending ease and the economy lose momentum, he said, Fed policymakers would have cover to begin lowering rates, perhaps as soon as their May meeting.

"With the cost of, and access to, borrowing being restrictive, this is a clear headwind that will help slow the economy through the first half of 2024 and make the Federal Reserve more amenable to the idea of interest rate cuts," Knightley said.

The chief executive of BOK Financial in Tulsa, Oklahoma, echoed other bankers in recent weeks when he noted in an interview that lending slowed in the fourth quarter, yet he expects renewed momentum as 2024 wears on.

The $49.8 billion-asset bank reported loan growth of more than 6% over the entire 2023, though it slowed to 1% from Sept. 30 to Dec. 31. Stacy Kymes, BOK's president and CEO, predicts the bank will return to a 6% growth rate, or perhaps do better, this year. Lower interest rates would play a key role.

"We fully expect this year to be a growth year," he said.