Lending Appetite

Appetite - a simple expression of "desire" from a sales perspective. How "hungry" is the sales dealership? "Are they hungry enough to make the deal I want? If they're hungry, they'll agree to what I've proposed". But from another perspective, if a manufacturer has significant inventory, they may have appetite. In addition to slow sales and inventory, appetite can can change depending on positioning in the marketplace, a drive for higher market share, territorial competition, an investor or shareholder's demands for results, or new management.

Now fast-forward to the banking and lending community.

Appetite in banking may depend on a bank's capacity to lend, often a function of deposits and available liquidity. For example, if a bank has seen a decrease in depositors, they may also have a corresponding lack of loan appetite. Couple with this the actual source of funds a lender may use for loan offerings. A lender needs a source of funds for heavier borrowing, and if there is no liquidity in this market (i.e. if a lender "sells" their loans to Wall Street in packets), lending capability is restricted. If the neighbor's daughter has a lemonade stand but cannot get her hands on a steady supply of lemons, her capability to offer her product is likewise hindered.

A bank's appetite may also depend on it's current financial strength (profitability) and rating by it's auditors, and the recent reviews by same auditors. If the Fed audits a bank and clamps down on their lending practices, the bank will focus more internally on it's policies and procedures, and in booking loans consistent with the tighter standards. But as a result, tighter lending practices will be forced on the banks by the Fed who are in part auditing to ensure a strong financial system, and they're the same group trying to push liquidity into the market to encourage more lending.

Bank appetite may also vary depending on current default activity. If a lender is engaged in recovering assets from current note-holders, their focus may not concern ongoing expansion of their loan portfolio. From a practical standpoint, if the Titanic is sinking, the Captain isn't thinking about how to design a better boat, he's focused on preserving the ship and the people in it. If banks can quantify their losses through defaults and take the charges/ write-offs, they will bottom-out.

But new loan volume will at some point become important to the lending community again. Loans eventually go away, whether through refinancing, sale of an asset (and payoff of corresponding debt), maturity of the debt - full payoff, or through the default and resultant write-off. But at some point, loan portfolios will start to shrink and a bank will recognize the need to generate new loan volume, thereby resuming the hunt for income producing loans.

So we have sifted through the elements comprising appetite that will create a more favorable lending environment today and a return to loan growth. With a decrease in the current level of defaults, and a growing desire to start booking loans again, the system starts to clean itself, resulting in increasing profitability of the banks. As the market starts to heal and the banks start to heal, appetite will return.