This page has been archived and commenting is disabled.

There Goes The Final Pillar Of The US "Recovery": The Loan-Growth Paradox Explained

Tyler Durden's picture




 

With the manufacturing side of the economy now openly in recession (based not only on earnings call confessions, regional Fed surveys, but an inventory-to-sales spread that has never been greater and is screaming liquidation, as well as an energy sector that has been in freefall for the past year), and the US consumer - that 70% component of US GDP - slamming into a wall following not only three months of disappointing payrolls, non-existent wage growth, plunging retail sales, a high-end consumer that has stopped spending, and the lowest consumer confidence measured by Gallup in 2015, not to mention GDP itself, there were just two pillars of the so-called recovery that had not yet been crushed: housing and loan growth.

Then yesterday, courtesy of the largest US mortgage lender, Wells Fargo, we learned that housing (all housing, not the tiny subset that is the all-cash "market" for ultra-luxury duplexes in NYC or San Fran which is only a function of how much laundered money Chinese oligarchs can park into the new "Swiss bank account" that U.S. real estate has become) was also rolling over after the worst quarter for mortgage applications in since the abysmal 2014.

Which left commercial bank loans as the last remaining pillar of any so-called "recovery."

It was here, that after posing virtually no growth for over two years, starting in 2012, US bank lending, led by Commercial and Industrial or C&I lending growing at a double-digit pop, started to rise at an impressive pace, asking many to wonder: maybe the biggest driver for a sustainable economic recovery is in fact present, because where there is loan demand, there is velocity of money.

Then a few years later, as the loan growth persisted with virtually no above-trend GDP growth to show for it, some - such as us - wondered: we know there is a "source of funds", but what about the "use of funds."

The first flashing red flag appeared last July, when we reported that companies were using secured bank debt to repurchase stock: a stunning, foolhardy development, comparable to taking out a mortgage on one's house and using the proceeds to buy deep out of the money calls on the S&P 500.

This is what the FT said at the time:

For the top 25 US commercial banks by assets, C & I lending grew by 10.5 per cent in the quarter to June 25 from the previous quarter, according to annualised weekly data from the Federal Reserve.

 

This type of lending is an important source of business for the largest US banks, representing about a fifth of all loans made by the likes of Bank of America, JPMorgan Chase and Wells Fargo, according to Citigroup research. While low interest rates have made business lending less lucrative, the relationships it forges open doors for the banks to sell other services such as treasury management, hedging and leasing.

 

A second corporate banking executive at a large regional lender said: “The larger part of the usage in the market right now are loan refinancings where companies are paying dividends back out.” He added: "They’re requesting increased loans or usage under a lien in order to pay a dividend or equity holders of a company. Traditionally banks have been very cautious of that."

Incidentally we explained all of this back in April of 2012 when we laid out why there simply can not be capital spending-fueled growth, when corporate shareholders can make far greater and faster profits using funds to splurge on buybacks, dividends and M&A - uses of capital that generate little or zero actual revenue growth.

After scratching our heads for a few weeks afterward, we let the subject go: after all there is no way banks would be lending companies secured loans to use the proceeds to cash out existing stakeholders, in the process asset-stripping the corporation. This would mean that the loan officers at these banks are either criminally stupid, or corrupt and have been bribed by the borrower to close their eyes when signing the dotted line and wiring the funds.

We promptly forgot this bizarre tangent into the "use of loan funds"... Until today when we found that it was, indeed, all a lie and that the banks themselves had become complicit in perpetuating not only the worst possible capital misallocation, but being an accessory to the US stagnation, soon to be replaced with full-blown recession.

This is what CLSA's Chris Wood found when looking at the several most recent loan officer surveys:

... from the standpoint of the corporate sector, zero rates tend to encourage financial engineering over capital spending while also allowing non-competitive businesses to survive for longer. The financial engineering incentive provided by such policies has been most evident in America where share buybacks and M&A activity have surged even as capital spending has continued to disappoint. Thus, the latest data shows that S&P500 share buybacks and dividends rose by 6.6% YoY to a record US$923bn in the year to June, while total reported earnings declined by 8.4% YoY to US$841bn over the same period.

 

And here is the punchline:

Similarly American banks, in terms of the quite impressive pickup seen in commercial and industrial (C&I) loan growth (see Figure 10), have been financing financial engineering, be it M&A or share buybacks, not capex. Thus, C&I loans rose by 10.7% YoY in September. Yet in the Fed’s July Senior Loan Officer Survey, 26% and 18% respectively of US banks reporting stronger C&I loan demand stated that the ‘very important’ reason for stronger loan demand over the past three months were financing needs for M&A and debt refinancing, compared with only 6% for capital investment (see Figure 11). Meanwhile, the lack of healthy creative destruction associated with zero rates has long been associated with the Japanese experience of so-called zombie borrowers.

 

There is the explanation of the paradox of surging C&I (and overall) loan growth, which took place even as overall economic growth and capital spending never followed. The reason? All that secured C&I debt was going not toward growth capital spending, or even maintenance/replacement CapEx, but simply into financial engineering: M&A and debt refis, the first to cash out the CEO of the acquiring or target company (with the generous blessings of the lender bank), the second to lower the cost of debt so more cash could be retained however not to grow the business but simply to fund the equity portion of said M&A.

Meanwhile the loan demand associated with actual economic growth: a paltry 6% of the total!

And while we are delighted to close the loop on this last "leg" of the recovery stool, one which stuck our like a sore thumb against a rapidly deteriorating economic landscape, confirming that we are indeed facing a recession and a very ugly one at that since the Fed can no longer cut rates even as the "economic-impact" credibility of QE is gone, what is more important is that this should be a lesson to everyone to remember that when money is transferred or when a loan is made there are always two sides to the equation: a sources of funds, and a use of funds. Because while everyone was focusing on the former, nobody remember to look at the letter.

It is the latter that has made all the difference to the US recovery, or complete lack thereof.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Thu, 10/15/2015 - 20:14 | 6673434 TBT or not TBT
TBT or not TBT's picture

Give me capex or give me debt!

Thu, 10/15/2015 - 20:29 | 6673474 mvsjcl
mvsjcl's picture

And, of course, none of this was orchestrated at the highest levels. ALL these global conglomerates decided independently of each other to pursue this foolhardy plan.

 

It really sucks watching this.

Thu, 10/15/2015 - 20:44 | 6673532 HalinCA
HalinCA's picture

It really sucks knowing you are going to get sucked down in the down wash...

Thu, 10/15/2015 - 20:21 | 6673446 sidiji
sidiji's picture

every single black mayor, governor etc etc in the US has managed to run his jurisdiction into the ground, go vist DC or Detroit.  what made people think a black man as president would be any better?

 

Thu, 10/15/2015 - 20:32 | 6673484 ZippyDooDah
ZippyDooDah's picture

Black, white, male, female:  the person of the figurehead makes no or little difference.  TPTB have run this ship right into the shore.  Obama is just reading a script fer Chrissake!

Thu, 10/15/2015 - 20:25 | 6673454 nakki
nakki's picture

Someone has to be selling into all those buybacks. Pull the rug, get free money and buy all those stocks at the bottom. Own all the corporations. That's what happens when you own the printing press.

Thu, 10/15/2015 - 20:27 | 6673462 Hype Alert
Hype Alert's picture

"Someone has to be selling into all those buybacks"  That would be the people approving the buybacks, the insiders.

 

Basically they are recycling option shares with company debt. 

Thu, 10/15/2015 - 20:42 | 6673525 HalinCA
HalinCA's picture

Gold star.

Fri, 10/16/2015 - 07:35 | 6674418 explosivo
explosivo's picture

Excellent point. And the capital became available by the bank stealing from the savings of the productive class via inflation tax. This is sick. 

Thu, 10/15/2015 - 20:39 | 6673510 Doubleguns
Doubleguns's picture

Business: I need a loan to go to Vegas. 

Banker:  No... only for capital improvements. 

Business: Ok, if I win I will buy some new equipment.

Banker: if you lose?

Business: I will buy a great big dildo to screw you with.

Banker: Sounds good. Heres your loan. 

Thu, 10/15/2015 - 20:41 | 6673518 HalinCA
HalinCA's picture

A classic Tyler post. BZ sir!

Thu, 10/15/2015 - 21:00 | 6673592 NDXTrader
NDXTrader's picture

I recently quit a job as an attorney doing mid-market commercial finance. Business was booming and this article is completely correct. The only loans we saw were banks lending to Private Equity, who were then buying out companies, firing the workers, reducing CapEx, and then trying to flip what was left for a profit. Everyone is just trying not to be the one standing when the music stops

Fri, 10/16/2015 - 00:58 | 6674082 GooseShtepping Moron
GooseShtepping Moron's picture

I am rather suprised that this was news to anybody, most of all to Tyler Durden. This is the paradigmatic case of predatory capatalism that we have all been watching and discussing for years. Ordinary people feel powerless against ths type of monetary piracy. It explains a great deal of the current malaise and the appeal of outsiders.

Thu, 10/15/2015 - 21:11 | 6673629 buzzsaw99
buzzsaw99's picture

the fed will paper over the asset stripping operation the same way they help defraud bank regulators with serial eoq repos

Fri, 10/16/2015 - 04:23 | 6674261 fowlerja
fowlerja's picture

Hey boys and girls..let's give the CEO's credit for increasing their stock price by the most efficient way. They could do it by inventing new products, using CAPEX funds to make the items and hire people to put the package together. God ...that's alot of work. Isn't there another way to increase our stock price?

 The "old fashioned" way is so outdated. Let's get together and see what our banker friends can do for us...Well they can lend us cheap money.. maybe 2.5%..we can buy back some of our company stock..and Wall Street will ensure we get a better price for our outstanding shares..hey maybe even 10% better. I think we all can appreciate how "spreadsheet modeling" of our company can make this happen..Does anyone have an objection...good...let's make this happen quickly...remember guys...you cannot spend your extra bonus until this is a done deal... if anyone needs cash now..well see the CEO..he can help you get the money you deserve...and our CEO...no he is not a loan shark..he is here to help you...

Fri, 10/16/2015 - 07:19 | 6674393 matagorda
matagorda's picture

Oh ye of little faith!  For one thing, I have discovered in reading the book "The Alchemists" that it is not true that the bernank had no relevant government or business experience before heading the fed.  In fact, he served on the Princeton, NJ school board!  So there!  Surely it is not for us of the great unwashed to fathom the magnificent machinations of the wise leaders who guide us, but to merely gaze in awe and humble respect!  ...I think I'll stop there...

Fri, 10/16/2015 - 12:36 | 6675502 Starkman
Starkman's picture

". . . the banks themselves had become complicit in perpetuating not only the worst possible capital misallocation, but being an accessory to the US stagnation, soon to be replaced with full-blown recession."

Hmm. So, the banks aren't allowed, or shouldn't be allowed, to lend money to a corporation that has a fairly secure way of ensuring the bank a ROI. For the bank to loan a corporation money that won't go into R&D and other methods to create or keep jobs is a no-no? That's odd, because prior to this statement, the author said, "The larger part of the usage in the market right now are loan refinancings where companies are paying dividends back out.” He added: "They’re requesting increased loans or usage under a lien in order to pay a dividend or equity holders of a company. Traditionally banks have been very cautious of that. [bold emphasis the author]"

But wait. The author then says, "After scratching our heads for a few weeks afterward, we let the subject go: after all there is no way banks would be lending companies secured loans to use the proceeds to cash out existing stakeholders, in the process asset-stripping the corporation. This would mean that the loan officers at these banks are either criminally stupid, or corrupt and have been bribed by the borrower to close their eyes when signing the dotted line and wiring the funds."

Oh, so after quoting a bank exec who clearly said that it's not the "traditional" environment in which banks loan to corporations, now the author says, by the authority of himself, that there is "no way" banks would loan in the aforesaid enviroment. Which is it: a right the bank has to loan under the circumstances noted but rarely does so, or that there is no way a bank would do so?

Companies are taking economic hits (never mind the reasons why), hard hits, and all the R&D in the world isn't going to make people buy what they don't have money with which to buy; I'm one of those people, along with how many more millions.

So, these companies will end up firing people, cutting back, even shutting down even if they borrow to continue the fruitless expectations of developing growth (well, a few just might succeed). Instead, some of these companies are buying back their own stock, and yes, firing people, which they'd have to do anyway. So, is what the bank is doing wrong: lending to allow a corporation to cut back, fire people, make a profit, having done all legally? No, it isn't. Plain and simple. And it's not unethical either.

No business is ethically or morally required to provide you or me a job or to keep you or me as an employee. They don't owe you or me anything. So just because they stay ahead and even profit in the midsts of a collapsing ecomony and horrible unemployment rate, that's a bad thing because you or I don't like that? Well, too bad! That is the right they have, the right you and I would have if we owned the company. And I wouldn't put it past 90% of you to have done the same thing were you in these corporations' shoes. It's business.

So, unless the banks and/or the corporations have broken the law, welcome to business and Capitalism in tough times, the manner of business I'd much rather deal with than Socialism or any of the other Isms.

Fri, 10/16/2015 - 12:53 | 6675580 MASTER OF UNIVERSE
MASTER OF UNIVERSE's picture

If that is the final pillar when is the edifice going to implode?

 

Inquiring minds want to know?

Do NOT follow this link or you will be banned from the site!