Commercial and industrial loans lead growth
According to the latest Federal Reserve data released on June 12, 2015, commercial and industrial loans at all US commercial banks increased by 12.5% YoY (year-over-year) in the week ending June 5, 2015. This segment has seen growth over 10% for almost a year now.
The above graph shows weekly YoY growth in commercial and industrial loans. The growth in this segment indicates increased business activity—a positive sign of economic growth. Banks are also more focused on commercial lending because the demand for residential mortgages and consumer loans remains depressed.
Inventory growth drives demand
The ISM’s (Institute for Supply Management) inventories index for May increased to 51.5%, indicating growing inventories. The new orders and production index for the month, too, showed growth. Inventory growth accompanied by growth in new orders and production may indicate that businesses have a positive economic outlook. Inventory growth drives demand for commercial and industrial loans.
Capacity use rate slips in May
Industrial production was down by 0.2% in May, according to federal data released on June 15, 2015. The industrial sector’s capacity use dropped 0.2% in May. At 78.1%, use is 2% below its long-term average for the period between 1972 and 2014.
A decline in capacity use is generally associated with higher charge-offs and credit costs for commercial and industrial loans at banks. This hurts bank profits.
Increased competition and easing standards
A concern associated with the rapid growth in commercial and industrial loans is that banks have loosened underwriting standards to disburse more loans. This could increase the risk to banks. Although the default rates are down, the risk might increase if the economic situation gets worse.
J.P. Morgan (JPM), Citigroup (C), Bank of America (BAC), and U.S. Bancorp (USB) have a greater proportion of their portfolios in commercial loans. These banks and the Financial Select Sector SPDR Fund (XLF) should benefit from growth in this loan segment.