Big Changes in Lending in 2019
If banks pull back, the economy will contract
Major banking institutions told the Federal Reserve they would tighten lending standards should short-term interest rates rise beyond their long-term counterparts, the central bank shared in results of an October survey of senior loan officers. Asked how an inversion of the yield curve would affect lending practices, a "major share" of banks responded they would become less profitable and more risk-averse. As the treasury comes close to inverting, banks have started reevaluating their risk appetite of new loans. What does this mean for the economy? Do you have a backup if a bank pulls the plug on financing?
If you plot short- and long-term rates on a graph in a growing economic cycle, as short-term rates increase, long-term rates should increase. Long-term rates are a gauge of long-term economic prospects and as they increase they signify the market anticipates future growth. If the short-term rates and long-term rates invert – meaning short-term rates are more expensive than long-term rates – the market is warning that long-term growth prospects aren't good. The yield curve has accurately predicted the last seven recessions. Currently the yield curve is flat with predictions of an imminent inversion.
This is a clear sign that the market is not buying the long-term economic growth prospects in the U.S. economy and a warning that short-term rates should not be rising as fast as they are.
Why are banks pulling back?
Banks are nervous about the long-term economic outlook. Bankers are typically a conservative bunch and do not want to make loans at the peak of the cycle that could default after the economy changes. Bankers also do not want to have the risk of reserving and tying up crucial cash for bad loans like they did in the last cycle. Cash is king when the economy heads south and bankers want to ensure they have plenty around this late in the economic cycle.
How will this impact borrowers?
Banks will be more conservative with their lending and retreat by further tightening lending standards on both residential and commercial loans. If a transaction is not picture perfect, it will likely not be funded through a traditional banking institution. More transactions will fall out of traditional lending in 2019 due to the tightening bank standards.
How will this impact the economy?
As banks pull back, the economy will contract.
Without financing, business will neither expand nor buy the new equipment and software. This will have a cascading effect on the economy, with less liquidity in the markets.
What is an alternative to traditional bank lending?
With banks pulling back and more transactions falling out, it is critical to have a plan B to ensure transactions can be funded.
Fortunately, there are alternatives to traditional lending that can get deals done as banks tighten. One alternative is a hard money loan or private loan. For instance, if a borrower has great credit but might not show enough income because he or she runs a small business, they likely will not be funded through a traditional lender. a private lender portfolios their loans so they aren't bound by the same rigid rules as a bank and would likely be able to fund this situation based on ample collateral.
As banks continue to tighten their lending parameters, work toward an honest answer to get your transaction closed with a true portfolio lender.