Checking In on Loan Supply and Demand as 2024 Winds Down

The Fed’s latest Senior Loan Officer Opinion Survey (SLOOS) hit the wires last week, giving investors a look into America’s credit markets. Under the hood, this was a pretty mixed report that doesn’t suggest a lending boom looms. Yet longer-term credit supply and demand trends still appear to be normalizing from recent weakness—a tailwind for the economy and stocks, in our view.

Start with demand. The net percentage of banks reporting stronger demand for commercial & industrial loans was negative for all firm sizes in Q4.^[i] Not great, considering declines in demand had been moderating after deep contraction for much of 2022 and early 2023. It had even reached a flat reading last quarter. Yet Q4’s tumble wasn’t totally unexpected. As Exhibit 1 shows, loan demand has moved roughly opposite long-term interest rates in recent years.^[ii] Since long rates serve as the baseline for most longer-term bank loans, their movement can affect borrowers’ costs and have a strong influence on demand. The period 2012 to 2014 is instructive: As rates trended higher, the share of banks reporting stronger demand ticked down. When rates reversed course thereafter, so did demand. Now, events like 2008’s financial crisis and the COVID pandemic inject other factors—namely, major macroeconomic worry—but since 2022, the pattern has overall held. So the uptick in long rates lately may have dinged demand.

Exhibit 1: Fewer Banks Reported Stronger Demand in Q4

Source: Federal Reserve Bank of St. Louis and FactSet, as of 11/20/2024. Net percentage of banks reporting stronger loan demand to large, middle market and small firms and 10-year US Treasury yields, daily, 10/1/2008 – 10/1/2024.

But even beyond this, there could be another factor at work: election uncertainty. Yes, 10-year Treasury rates began rising in September, which could be contributing to the latest demand wiggle. But they had been falling earlier in the quarter, so we suspect some other factors are at play here. Especially since the Fed’s report noted falling financing demand for property, plant and equipment (PPE) investment and mergers and acquisitions (M&A) in Q4. Smells to us like businesses waiting for post-election clarity before making major, longer-term investment plans. Plus, inventory financing demand fell slightly after months of restocking.

On the supply side, the net percentage of banks tightening loan standards fell to zero for large and medium corporations, suggesting bigger firms have easier access to credit. Standards tightened slightly for small firms. But as Exhibit 2 shows, banks’ standards have been moderating for all firms since Q3 2023.

Exhibit 2: Q4’s Diverging Loan Supply

Source: Federal Reserve Bank of St. Louis, as of 11/20/2024. Net percentage of banks reporting tighter loan standards to large, middle market and small firms, Q4 2008 – Q4 2024.

Considering banks adjust their lending standards based on their economic outlook and loan profitability, Q4’s data aren’t too surprising. For one, recession fears have eased for months amid growthy GDP and other data. And while the US Treasury yield curve—the difference between long and short rates and a proxy for banks’ profitability—is ever so slightly inverted (3-month rates slightly top 10-year), banks’ deposit rates have long been below short-term interest rates.^[iii] This factor is, in our view, what made Fed hikes have so little macroeconomic effect. If banks are awash in deposits, they don’t need to borrow from each other at overnight rates—or pay depositors much more to attract funding.

Now, the big swings from recession worry seem almost out of the data for large firms entirely. Smaller firms still seem to face some lingering worry, as the percentage of banks tightening standards rose from Q3’s net 8.3% to 13.3% in Q4.^[iv] Mind you, this is still below Q1 and Q2 2024’s readings—it wasn’t a sharp rise—and it is just one reading amid a broader trend of less restrictive standards. But it is probably worth noting that more banks are tightening standards for small firms than most of the span between 2008’s aftermath and the pandemic.

So it wasn’t a great report overall, but longer-term positive trends still appear on track. Loan supply and demand are still in a much better place than last year, and Q4’s report largely showed a continued, gradual normalization in both. It remains to be seen whether election clarity will boost demand—it is possible but worth watching. However, history suggests loan supply, or banks’ willingness to lend, is more influential for overall loan growth. Consider the 2010s’ steady run of C&I loan growth. Banks’ loan standards were pretty loose throughout the decade, but loan demand fluctuated—mostly positive during the front half and mostly negative in the back half. Total lending can grow even if demand wobbles.

As far as investor takeaways go, we think stocks have been pre-pricing these trends for months now. There are certainly other factors at play, but we doubt US stocks would be floating near all-time highs if loan growth—a major economic growth driver—was about to falter.