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Lending
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With a recession on the horizon, the landscape for financial institutions will become more difficult for the rest of 2022 and into 2023. Rising delinquencies, tighter margins driven by an inverted yield curve, and softening loan demand due to higher rates will pose a series of challenges.
Loan Demand
More restrictive monetary policy is having the desired effect of slowing lending activity. Mortgage loan applications fell to 22-year lows in July with refinancing activity dropping more than 81% from a year earlier with 30-year mortgage rates over 2% higher than a year ago.
Similarly, auto lending has also begun to slow down. While still positive, growth in auto lending has cooled from earlier this year. While continued supply chain disruptions have contributed to this, higher rates are having a clear impact.
Consumer Credit and Home Equity Loans
Two areas of lending that are seeing growth because of negative real wages are consumer credit and home equity loans.
Both have seen noticeable increases in recent months and auger opportunities for financial institutions looking to offset loan volume declines in other categories. These two lending categories really picked up about a year ago when inflation started accelerating, squeezing consumers’ purchasing power.
Commercial and Industrial
Another area of lending which has been holding up well is commercial and industrial.
Volumes have once again begun to pick up. However, the outlook for this category of lending is cloudy at best. Some businesses may utilize lines of credit to weather the recession while others may pull back on lending due to the uncertain outlook. Higher rates will inevitably curtail demand in this space as the year wears on.
Deposits
As Americans continue to grapple with the effects of inflation outstripping their wage gains, much of the savings build up during the pandemic is being used to keep purchases going.
The result has been a significant drop in savings rates and a gradual reduction in deposits at financial institutions. We expect this trend to continue as long as inflation outpaces wage gains.
Delinquencies and Insurance Coverage Lapses
As noted before, delinquencies are beginning to pick up on just about every form of consumer credit. While these rates may not reach levels seen in 2008 and 2009, they will represent a material event financial institutions will need to manage.
Additionally, lapses in insurance coverages on assets (homes and autos) are also increasing. In addition to default risk, financial institutions will be faced with the need to protect the underlying assets they are lending against to reduce losses from accidents, fire, floods, weather, etc.
Margins
As we have eluded to, net interest margins will be squeezed further from already thin levels as the yield curve remains inverted or flat.
Coupled with lower loan demand due to higher rates, financial institutions will have to look to other sources for revenue growth and likely need to take steps to manage expenses.
Net interest margins should begin improving later this year or by the first quarter of next year as bond market sentiment gradually improves.
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