Risk

Banks Turn Corner on Business Loans

Fiercer domestic competition is making U.S. banks more flexible on spreads, interest-rate floors, and other costs to borrower companies.
Vincent RyanApril 30, 2012

Business lending in the United States looks to have definitely turned a corner, with domestic banks and U.S. branches and agencies of foreign banks reporting easing terms for commercial and industrial (C&I) borrowers last quarter, while also saying demand for such loans had picked up.

While banks aren’t changing their yardstick for who gets credit, many are easing the terms — at least to large and middle-market firms, according to the Federal Reserve’s Senior Loan Officer Survey on Bank Lending Practices, released Monday.

About 58% of the 81 financial institutions surveyed said they cut the spread over cost of funds that they charge borrowers, and 32% said they reduced their use of interest-rate floors. About 17% said they lowered the other borrowing costs that come with a line of credit. This is a change from the Fed’s January survey, when banks reported that lending standards and terms were static. Standards and terms for small companies, however, remained basically unchanged in the first quarter.

A more positive economic outlook doesn’t appear to be driving the changes on C&I terms. Neither did many bank officers cite an improvement in their bank’s capital position or a higher tolerance for risk. Instead, almost all domestic U.S. banks said “more aggressive competition” from other banks and nonbank lenders had forced them to respond with softer terms.

Greater demand for C&I loans carried over from the fourth quarter of 2011. More banks than not said that inquiries from businesses about new or larger lines of credit had risen. Among the reasons the banks cited for the lift in demand were companies’ need to finance accounts receivable, to invest in plant or equipment, and to finance acquisitions. However, the shift in demand was also attributed to customers switching banks.

The euro zone crisis continued to affect some kinds of lending. Some U.S. banks reported tightening on loans to financial institutions headquartered in Europe and their affiliates or subsidiaries, as well as to U.S.-based nonfinancial companies that have significant exposure to European economies.

However, the number of banks reporting so diminished from the fourth quarter. The larger effect from the euro zone crisis, at least currently, is the aggressiveness of overseas banks in pursuing U.S. business customers: two-thirds of domestic U.S. banks that normally go head-to-head with European banks said they saw less competition from them last quarter.

The picture for residential real estate lending that the Fed survey painted was much murkier. While more banks on net reported increasing residential real estate mortgage assets, “several large banks,” the Fed said, “anticipated reducing their exposures somewhat or substantially.”

While some banks reported increased demand for residential real estate loans, a majority said they were less willing to originate loans eligible for sale to government sponsored enterprises (GSEs). The most important factor, cited by the largest number of banks, was the higher risk of “putbacks” of delinquent mortgages by the GSEs. (Putbacks are when a mortgage security holder forces the originator to repurchase the loan.) Banks also said borrowers were having more difficulty obtaining mortgage insurance. Other factors cited for shying away from such mortgages included the individual financial institution’s exposure level to residential real estate; concerns over legislative changes, supervisory actions or accounting standards, and the prevailing spread of mortgage rates over cost of funds being insufficient to compensate for risks.

The Fed’s survey on lending practices for the first quarter polled 81 financial institutions in total.