The economy is all about cycles: business cycles, sentiment cycles, and so on.
To Matthew Mish, a strategist at UBS, there may be none more important than the credit cycle.
“We firmly believe in credit cycles: the expansion and contraction of access to credit, which foreshadow changes in credit spreads and shifts in business and asset prices,” Mish wrote in a note Thursday.
Essentially, the access, or lack thereof, to loans presages major changes in the overall economy.
The loan market at US banks has Mish worried about the credit cycle and it’s been preventing him from getting enough sleep.
From his note (emphasis added):
“For this we turn to the Office of the Comptroller of the Currency’s (OCC) 2015 Survey of Credit Underwriting Practices released in December, which assesses credit underwriting standards at 95 banks with assets of $3bn or more, on loans totaling $5.1tn (94% of total loans in the federal banking system) and covering 18 commercial and retail credit products. And the results, frankly, have kept us up some nights.”
As a quick and simple reminder, the credit cycle typically goes through a period of expansion, with banks lending to consumers and companies. Then it gets too loose and standards on these loans get low, allowing unqualified borrowers to access debt. Then the bubble bursts, defaults rise, and fewer loans are issued.
The big worry, said Mish, is that the current standards at banks are now low enough that credit issuance looks a bit bubbly.
“The survey concludes underwriting standards eased at a significant number of banks for the three-year period from mid-2013 to mid-2015, broadly similar to that experienced from 2005 to 2007 before the financial crisis,” wrote Mish.
The main reason for this relaxing of standards is competition. Banks have issued a large number of loans since the end of the last recession, so they are trying to keep increasing business with fewer borrowers needing loans.
The most worrying areas, said Mish, were commercial real estate, construction and indirect consumer loans.
While Mish believes this is not a sign of an imminent end to the credit cycle, he thinks that is turning from “boom to bust.”