Risk Management

Banks Racing to Bottom on Terms and Rates

Many banks are still lowering their underwriting standards for business borrowers and lending at smaller spreads over their cost of funds.

U.S. banks lowered business lending standards last quarter, as financial institutions scrambled to win corporate borrowers as customers. Many went as far as to lower spreads on loans, which are already razor-thin and cutting into financial institutions’ profitability. Many banks also eased up on covenants. 

The indications of banks’ stances on business borrowers came from the Federal Reserve’s quarterly survey of senior loan officers, released Monday. The easing was applied to all-size borrowers, for the most part, and the most oft-cited reason was heated competition from other lenders. “Of the domestic respondents that reported having eased either standards or terms on C&I loans over the past three months, all but one cited more-aggressive competition from other banks or non-bank lenders as an important reason for having done so,” the Federal Reserve said in its report. 

Forty percent, however, said a more favorable or “less uncertain” economic outlook was also a contributor.

The slip in underwriting standards was similar to what loan officers indicated in the Fed’s January survey, which covered the last quarter of 2012, and continued a loosening trend that has accompanied the Federal Reserve’s quantitative-easing strategy.

Senior loan officers also said that business-loan terms were  modified to be more palatable to borrowers. “A very large fraction” of bankers said they had cut spreads on C&I loans over their bank’s cost of funds, for example. A slightly smaller percentage reduced the cost of credit lines and lessened the use of interest-rate floors for C&I loans. Fewer banks – about half of those surveyed –said they eased loan covenants for large and middle-market firms.

For small companies, covenants were largely unchanged, and generally banks were less apt to ease terms for them, holding to existing standards for things like collateralization and the size of the credit line they were willing to extend.

Branches and agents of non-U.S. banks said their lending standards to companies had remained unchanged. But a “moderate” number loosened terms, according to the survey. In some cases, foreign banks increased the maximum size of corporate credit lines and reduced the premiums they charge on riskier loans, the Fed said.

The loan officer survey did not answer the question of where business borrowing demand is headed.  Small banks and big banks had an opposite response to the question of whether more businesses were applying for loans. Large banks reported a net decrease in the number of inquiries from potential business borrowers regarding new or increased credit lines, the Fed report indicated. But on balance, small and midsize banks said demand had strengthened, “citing increases in customers’ funding needs related to investment in plant or equipment, inventories, and accounts receivable,” according to the Fed.

Senior loan officers at 68 domestic banks and 21 U.S. branches and agencies of foreign banks responded to the Fed survey, conducted in April.

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