Senior Loan Officer Opinion Survey – Small positives, but …

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The Federal Reserve Board’s Senior Loan Officer Opinion Survey has just been published. This is an important document for assessing to what extent credit markets are thawing and confidence is returning to the financial system. The analysis below is a guest contribution by Asha G Bangalore* of The Northern Trust Company.

The latest Senior Loan Officer Survey reports a small but notable easing of loan underwriting standards but demand for loans was weak with the exception of residential mortgages. The number of banks tightening underwriting standards for commercial and industrial (C&I) loans to large firms was smaller in July (30%) compared with the results of the April survey (40%); the peak was a little over 80% of bankers reporting strict terms for borrowing in the fourth quarter of 2008 (see chart 1).

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The cost of borrowing also fell slightly for commercial and industrial loans but the elevated level of spreads suggests that credit conditions remain tight (see chart 2). This is running counter to the fact that credit market spreads have eased considerably (see chart 3).

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Chart 4 indicates that the demand for loans is weak. The survey included special questions about the reasons for the decline in loan demand. Bankers indicated that decreased loan demand and reduction in credit quality were the main reasons for weakness in lending.

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The excerpt from survey that is troubling runs as follows: “In response to a second special question, most banks reported that they expected their lending standards across all loan categories would remain tighter than their average levels over the past decade until at least the second half of 2010; for below-investment-grade firms and nonprime households, the expected timing is later, with many banks reporting that standards for such borrowers will remain tighter than average for the foreseeable future.” The credit machine is the life blood of a modern industrial economy. This response leads one to reconsider the prediction about the growth path of the economy.

The reasons bankers gave for tightening credit standards or terms for C&I loans not only matched those reported in the previous two surveys but also enhance the concerns cited above – “Both domestic and foreign respondents nearly unanimously cited a less favorable or more uncertain economic outlook, and large majorities cited a reduced tolerance for risk. Domestic respondents also widely noted a worsening of industry-specific problems, while foreign respondents were more likely to cite an increase in defaults by borrowers in public debt markets, as well as deterioration in their banks’ current or expected capital positions.”

After holding nearly flat in the April survey, the net percentage of domestic banks that tightened standards on prime residential real estate loans has declined to 20% from a peak level of about 75% one year ago (see chart 5).

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The net fraction of respondents that tightened standards on nontraditional residential mortgages dropped to about 45% from 65% in April. Fewer respondents indicated they were tightening standards for consumer loans (see chart 6).

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The willingness of banks to make consumer installment loans held nearly steady in the July survey (see chart 7).

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Source: Asha Bangalore, Northern Trust Daily, August 17, 2009.

* Asha Bangalore is vice president and economist at The Northern Trust Company, Chicago. Prior to joining the bank in 1994, she was consultant to savings and loan institutions and commercial banks at Financial & Economic Strategies Corporation, Chicago.

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