It is interesting that the market continues to focus on interest rates and employment as the barometer for the economy while totally ignoring one metric. As a lender I just did an analysis on our portfolio and one metric jumped off (chart above is my portfolio). In 20 years lending and servicing loans, I have yet to see this large of a change. What is the significance of the chart above? Why are many lenders saying the economy is gum drops and roses and yet taking one drastic step?
Much greater liquidity crunch than market is pricing in
There is a much greater liquidity issue than is being priced into the soft-landing narrative. Banks are pulling back substantially on real estate lending to anything other than perfect A paper loans. Without credit we will eventually see a pullback in the economy. We are seeing this both on the consumer and business side.
Consumer lending tightening:
The latest SCE Credit Access Survey reveals a notable decline in consumer credit demand in 2023. Most credit application rates weakened, except for applications for credit card limit increases, which rose.
Looking ahead over the next 12 months, households anticipate that they will be less likely to apply for a new credit card, auto loan, or a mortgage or mortgage refinance loan. Consumers also report significantly higher average perceived likelihoods of a future credit application being rejected, conditional on applying over the next 12 months.
- Reported rejection rates among applicants increased by 2.1 percentage points to 20.1% in 2023 from 18.0% in 2022, well above its 2019 level of 17.6%.
- The average rejection rate on mortgage refinance applications increased to 15.5% in 2023 from 9.9% in 2022.
- The average rejection rate for credit card applications during 2023 increased by 1.1 percentage points to 19.6%.
Business lending tightening.
According to a report from the Kansas city Federal reserve:
“Small business commercial and industrial (C&I) lending[1] declined sharply in the first quarter, decreasing 15.9 percent from the same period in 2022 and 6.8 percent from the previous quarter. Respondents reported declining loan demand for the fourth consecutive quarter, with the largest percentage of respondents reporting softening demand since the survey began. The 130 respondents to the survey indicated that credit standards tightened while credit quality decreased, and interest rates continued to rise”
Banks reacting polar opposite to the market
The interesting question is if the market is so convinced that we will avoid a recession then why are banks doing the opposite and tightening lending? One would anticipate just the opposite to occur. In good economic times lenders want to put money out as the risk of default is low and they make money on the spread between deposits and loan rates. Furthermore, in good times there is typically insatiable demand for well-secured loans as there is a premium over the treasury bill.
As noted above, lenders are sharply pulling back on both consumer, business, and real estate lending. Regardless of what banks are publicly saying on the economy their lending actions (or lack thereof) are telling for what is next for the economy.
My Loans serviced increased 400%
One interesting metric to highlight the sharp pullback is the dollar value and number of loans I am servicing. As a private lender, our portfolio typically turns as customers migrate into more conventional financing. We are meant to be used as a bridge as opposed to a long-term lender.
This year was radically different than I have seen in the last 20 years as a lender. Our portfolio grew substantially not due to increased lending as we are about flat, but a resounding decline in refinancing. As mentioned above conventional lenders are pulling back substantially and we are seeing this firsthand in the data on our portfolio.
The chart above is telling; you can clearly see huge jumps in notes serviced in 2023 while lending was about flat. Note on the chart I intentionally left off the servicing amount as we are privately held and funded and don’t disclose this information.
Will the liquidity crunch continue in 2024?
Looking at our data in q1, we are already seeing record low refinances in our portfolio as the trend from last year is accelerating with our lending portfolio continue to grow much faster than we have seen historically.
Furthermore, talking with our borrowers, I do not see this trend reversing in 2024 as lending standards are set to increase further and liquidity at many small/mid size banks remains a huge issue ultimately leading to substantially less lending.
This trend doesn’t appear to reverse anytime soon. Treasuries are staying higher than anticipated for longer which is further crimping the balance sheets of small/mid-size lenders.
The liquidity crunch will lead to a slowdown
Although the word recession has now been replaced by soft landing, I wouldn’t be so fast to go along with this narrative. The ability to borrow is critical to the health of the economy and without liquidity ultimately there must be a correction to some extent.
Commercial office properties are a good example, there is very little lending available on large office projects. Every time I look in the paper, another property has been given back to a lender. Unfortunately, prospective buyers are unable to finance a purchase even if they wanted to. This will force the office market to come into balance with substantially lower values to the tune of 40-50%. Office is an example of how the lack of liquidity will force a change in asset pricing. There are similar examples to the office market lurking beneath the surface throughout the economy from the residential auto market where borrowers are underwater to the corporate bond market with zombie companies.
Ultimately the market will go through a reset of asset prices that will lead to a slowdown in the economy.
Summary
I have no doubt that we are in for a huge reset in prices throughout the economy especially in commercial real estate. Recall, the last 20 years have been an era of cheap money which has substantially increased asset prices. As this era comes to an end something will undoubtedly break whether that is the consumer, businesses, or banks is the question. My guess is that ultimately many more small/mid size banks fail which will further crimp lending as the remaining banks will want to keep their liquidity so that they don’t become the next headline.
Fortunately I don’t see a 2008 repeat, but I also do not buy the fact that the economy is gumdrops and roses. The increase in my servicing portfolio is a huge indicator of the liquidity crunch that will roll through the economy in 2024 and ultimately lead to lower asset prices. When the dust settles someone will be holding the bag of losses, the mystery is exactly who and how big the bag will be.
Additional Reading/Resources
- https://www.newyorkfed.org/newsevents/news/research/2023/20231120
- https://www.kansascityfed.org/surveys/small-business-lending-survey/credit-standards-tighten-as-small-business-ci-lending-declines/
- https://www.cnbc.com/2023/11/07/credit-card-balances-jump-to-1point08-trillion-record-how-we-got-here.html
- Will real estate fall in 2024?
- https://www.newyorkfed.org/newsevents/news/research/2023/20231120
- https://www.kansascityfed.org/surveys/small-business-lending-survey/credit-standards-tighten-as-small-business-ci-lending-declines/
- https://www.cnbc.com/2023/11/07/credit-card-balances-jump-to-1point08-trillion-record-how-we-got-here.html
- https://www.fairviewlending.com/one-metric-for-risk-is-off-the-charts-impact-on-real-estate/
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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