BBT BB and T Corporation

Business lending abruptly downshifted in the third quarter, a puzzling move that may weigh on upcoming bank earnings.

For some time, business loans, also known as commercial and industrial loans, have been one bright spot for otherwise growth-starved banks, both large and small. But such lending fell by 0.1% in the third quarter, Federal Reserve data show.

Although small, the contraction from the prior quarter is the first such drop in six years, according to Morgan Stanley. That could drag on third-quarter bank earnings growth. Bank results are generally expected to be solid if not exciting. The biggest banks, such as J.P. Morgan Chase & Co., begin reporting Friday and into early next week; regional banks will report results over the next few weeks.

Possibly offsetting the drop-off: Other types of loans—including commercial real estate, mortgages and credit cards—grew in the quarter from the prior quarter, according to Fed data.

Bankers are hoping the sudden lurch in business lending is a blip. One point in their favor: the drop came shortly after Britain voted to leave the European Union, roiling markets and denting business confidence. After late August, business loans outstanding started recovering. Indeed, year-over-year growth rates for business loans remain positive, and that also rose through September.

So far, bankers are cautious and perplexed. "We see it slowing down over the course of the quarter, we don't know why," U.S. Bancorp Chief Executive Richard Davis said of commercial lending at his bank's investor day in September. "Is it affected by the pending election? Is it because of the Brexit? What is it?"

BB&T Corp. Chief Executive Kelly King in September attributed the slowdown to anxiety that may dissipate after the election. Mr. King says some of his clients have "trucks with 250,000 miles, 300,000 miles" and "20-year-old computers" but aren't investing in upgrades because of uncertainty about the future.

Other bank executives have hypothesized that seasonal changes in car dealership borrowing and less demand from energy companies may also be factors.

"You hear a lot of different anecdotal answers from customers," Grayson Hall, the chief executive of Birmingham, Ala.-based Regions Financial Corp., said in September, "Anyone's guess is as good as mine."

A drop in this type of lending, which consists of banks' non-real-estate loans to businesses, adds to banks' profitability woes. Overall bank profits have been under pressure for some time thanks to the lackluster economic recovery and superlow interest rates.

The gloomier scenario is that the business-lending metric is a sign of a broader economic slowdown that lasts beyond the quarter, said Barclays PLC analyst Jason Goldberg.

That could have further-reaching consequences, especially when it comes to the Federal Reserve and its next move on interest rates. Last December, relief seemed to be in sight for banks when the Fed raised rates and said it expected to continue hikes in 2016.

Such a move could be expected to boost banks' net-interest margins, or the profit margin they make by borrowing money from depositors and lending it out. But a further Fed increase has failed to materialize.

Until the Fed does so, banks must rely on loan growth to try to increase net interest income. Double-digit rates of commercial-loan growth in recent years helped with that effort.

The stall in commercial lending growth has prompted analysts to cut earnings expectations for some lenders. Morgan Stanley, for instance, last week trimmed estimates for the third quarter and 2017 for a number of banks including Comerica Inc., KeyCorp and Zions Bancorp.

Individual banks' loan growth often deviates from the broader Fed data, but many of the large U.S. lenders have also forecast a slowdown in these loans. Bank of America Corp., for instance, said loan growth had moderated in the third quarter because of less mergers and acquisitions activity and companies tapping less of their available lines of credit.

Write to Rachel Louise Ensign at rachel.ensign@wsj.com

(END) Dow Jones Newswires

October 13, 2016 10:35 ET (14:35 GMT)

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