By Robert B. Segal
The most recent Federal Reserve senior loan officer survey, released at the end of January, indicated further tightening of most standards for commercial lending. The extent of tightening was broad-based, while at the same time, the survey showed softer demand for most loan types. The Federal Reserve cited these conditions as part of their rationale for reducing the target federal funds rate so dramatically.
The percentage of banks tightening credit for C&I loans for large- and middle-market firms rose to 32.2 percent from 19.2 percent in October; the highest reading since 2002. The fraction tightening standards for small firms increased to 30.4 percent from 9.6 percent. For small firms, the net tightening remains below the peaks in 1990 (56.9 percent), 1998 (36.4 percent) and 2001 (59.7 percent).
The spread of loan rates over the bank's cost of funds was increased by 40.1 percent of respondents, up from 21.1 percent in the fourth quarter of 2007. The main reasons given for the tightening in terms were:
Less favorable or more uncertain economic outlook:
Worsening of industry-specific problems: and
Reduced tolerance for risk
The survey indicated significant tightening in commercial real estate loan standards, with a net 80.3 percent of banks reporting tighter standards, up from 50 percent in July and the highest reading in the history of the series, which goes back to 1990.
The survey also indicated more tightening on the household side as well, with more banks tightening standards on prime (52.9 percent from 40.8 percent), nontraditional (84.6 percent from 60 percent), and subprime mortgages (71.5 percent from 50 percent). The squeeze in other consumer loans came in the form of a higher minimum required credit score and a wider spread of loan rates over the bank's cost of funds. A net 35.8 percent of banks reported weaker demand for consumer loans in October, up from 26.5 percent in July.
The credit crisis is tightening the screws on thousands of small businesses across the country that depend on these traditional lenders for financing. For many businesses, it’s reminiscent of the early 1990s, when large banks pulled back from entire industry sectors, painting each and every company with the same broad brush.
The corporate lending market fared better than the mortgage market in 2007, suffering few of the symptoms of the current downturn. But the easy access to syndicated loans and to the commercial real estate conduits is probably a thing of the past. Larger banks troubled by problems with subprime lending are likely to continue tightening credit for corporate borrowers.
News reports during mid-March said that Citigroup is invoking the
material adverse change clause to back out of loan commitments, leaving borrowers at risk and casting doubt on contracts that have already been negotiated. Banks haven’t used this clause much since Sept. 11 and with spreads between commercial mortgage-backed securities and Treasuries at their widest in over a decade, some of the larger ones are applying this clause to avoid lending at below-market rates.
For several years now, small banks have lost business to their larger rivals. Big banks, for example, have muscled into the credit card and home mortgage businesses. Smaller banks also find difficulty in competing for automobile financing.
In response, many small and mid-size banks, especially those with assets less than $3 billion, pushed into commercial real estate and corporate lending. Believing that their local knowledge of markets would give them an edge, many forged ahead. The strategy paid off, delivering new sources of customers and strong revenue growth.
The largest banks may face credit losses for several years because they relaxed underwriting standards too much in an effort to generate loan business. They are now paying more attention to pricing properly for credit risk, which will bring much needed discipline back to the market.
The large banks will not be out in the marketplace building volume for the sake of building volume any more. Nor will they put the same effort into establishing relationships in the local community. Many of their customers will get discouraged in the process.
While the large banks lick their mortgage wounds, they’re likely to be less active in lending to corporate borrowers. This provides an opportunity for community banks to step in and fill the void. Without the burden of the risky ventures undertaken by their larger brethren, community banks should be well-positioned to take some market share.
Robert B. Segal is a chartered financial analyst and portfolio manager at Danvers, Mass.-based J. William Mantz Investment Advisors (www.jwmantz.com), an investment advisory firm serving more than two-dozen community banks, primarily on the East Coast. “At the Margins” is a regular feature in Banking New York focused on banking strategies and balance-sheet trends.