Loan growth at big banks cooled in the third quarter as lenders continued to tighten standards and softening demand signaled that a sharper downturn is ahead.

Gross loans increased by a median 0.7% sequentially during the period across the 15 largest publicly traded U.S. banks, down from an exceptional median increase of 4.4% in the second quarter, according to S&P Global Market Intelligence data. The gains in the third quarter did help support surging net interest income, and the growth appears to have some momentum left.

But another quarter of tougher standards and wider interest rate spreads in the Federal Reserve's most recent loan officer survey came as bankers also reported slackening borrower appetite for commercial and industrial, or C&I, loans for the first time in about a year and a half. The responses "were the softest they have been since early-pandemic and [Great Financial Crisis] periods," analysts at Jefferies said in a Nov. 8 note. Historical patterns "suggest slowing/declining loan growth and higher loss rates on the horizon."

C&I demand tumbles

Median sequential C&I growth across the group slipped to 1.6% in the third quarter from 6.7% in the second quarter as banks such as Wells Fargo & Co. and Fifth Third Bancorp said line utilization, which had generally been recovering after hitting pandemic lows, had leveled off.

The Fed's quarterly survey, published in November using responses due in October, was the second in a row showing net percentages of banks tightening C&I standards, with respondents citing factors that included a worsening economic outlook and less aggressive competition. A net 21.9% reported weaker C&I demand from small firms, compared to a net 17.5% reporting increased demand in the prior quarter. The demand reading for large and medium-size firms also swung into negative territory, with banks noting that customer inventory financing needs and investment plans have softened.

Historically, net tightening has been closely correlated with year-over-year loan growth with a lag of about six quarters, according to the Jefferies analysts, and the reading on demand is correlated with growth with a lag of about four quarters.

Median sequential commercial real estate loan growth across the group was 0.6% in the third quarter, according to Market Intelligence data. More than 50% of net respondents in the most recent Fed survey reported further tightening standards for construction and land development and nonresidential commercial real estate loans, and more than 40% reported further deterioration in demand in each of the two sectors.

Charging it

Borrower appetite for credit card loans continued to increase according to the most recent Fed survey, a lone bright spot in consumer credit demand as a surge in interest rates has hammered mortgage activity.

A net 18.8% of banks said they tightened credit card standards, up from 0% in the prior quarter. But the tightening appears to be concentrated in lower credit score customer segments, with a net 6.1% saying they are more likely to approve credit card loan applications from high credit score borrowers now than at the beginning of the year. A separate survey by the Federal Reserve Bank of New York published Nov. 21 showed credit card applications increasing from the year prior while the rejection rate declined.

Discover Financial Services executives during the company's third-quarter earnings call said they had marginally tightened underwriting, though for new accounts "it remains a very good environment."

The most recent data on credit card loan performance showed delinquencies drifting higher but staying near historically low levels.

Across the 15 big banks, closed-end, single-family mortgages increased a median 1.7% sequentially during the third quarter, reflecting portfolio decisions in addition to new loan activity, and consumer loans increased a median 1.6%.

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Q4 so far

Despite data signaling a slowdown, lending activity appears to have remained relatively strong in the year's final stretch, according to the Fed's most recent weekly data.

Seasonally adjusted total loans across the industry increased 1.4% from Sept. 28 to $11.851 trillion on Nov. 16, including 1.9% growth in C&I to $2.811 trillion. Credit card loans were up 1.2% to $928.14 billion, taking the year-over-year increase to 17.3%.

The "sharp dip" in demand contrasted with third-quarter loan growth, Raymond James analysts observed in a Nov. 7 note. But the Fed survey's results "were in line with management commentary on [third-quarter] earnings calls which reflected a growing cautiousness in loan growth's ability to persist at recent levels."