File this data under the category, “Signals that banks are restricting credit.”
After some easing of business lending standards in 2021 and 2022, domestic U.S. banks may be getting more scrupulous when it comes to borrowers and the terms they offer on commercial and industrial (C&I) loans.
The Federal Reserve’s second-quarter survey on bank lending practices released on August 1 found a significant net percentage (24%) of senior loan officers surveyed reported tightened standards for commercial and industrial loans (C&I) to large and middle market companies. And a net 12% of banks increased the spread between their cost of funds and the interest rate they charged on C&I loans. (See chart, Banks Begin Tightening Loan Terms.)
Moreover, the senior loan officers from the 69 domestic banks surveyed (minimum $2 billion in assets) indicated a more widespread tightening of standards for all C&I loans in the second half of 2022.
(The results of the Fed senior loan officer survey can be hard to decipher. When the Fed says “a net percentage of 24%” or “a net fraction” of banks, it’s referring to the percentage difference between the respondents indicating they had tightened terms to some degree and the percentage that had eased terms to some degree. In the second quarter, less than a handful of banks eased terms. However, as in most quarters, about 50% of loan officers indicated credit standards remained unchanged.)
During the second quarter, a significant percentage of bank officers (20% or more) surveyed said one of the tightening measures used was to charge a premium on riskier loans. Other measures included increasing the cost of credit lines, widening the spread over the bank’s cost of funds, and increasing collateralization requirements, according to the Fed survey.
The most popular reasons for the tightening changes were a more uncertain economic outlook, the bank’s reduced tolerance for risk, worsening of industry-specific problems for the borrower, and decreased liquidity in secondary loan markets.
Despite the incremental tightening, many banks reported stronger demand in the second quarter for C&I loans to large and middle-market companies.
Among the reasons for the healthy appetite, at least according to loan officers, were businesses’ needs to finance inventory and accounts receivable, demand for cash and liquidity buffers, and a shift in borrowing from other banks or non-bank sources.
That assessment of demand paralleled the acceleration in commercial loan growth banks reported in second-quarter earnings. The increase in C&I loan growth at major U.S. banks stemmed from increased line utilization, strong originations, and slower pay downs, according to analysts Michael Taiano and Christopher D. Wolfe in Fitch Ratings’ quarterly banking comment.
Loans officers project a bumpier second half, according to the Fed. They think borrowers’ debt-servicing capacity could worsen due to inflation and collateral values could deteriorate, among other things.
But bank’s earnings reports showed credit performance indicators were still very strong historically. Although the need to increase reserves for loan losses cut into U.S. banks’ second-quarter profits, it was due to the growth of C&I loan portfolios, not poorer loan portfolio performance, said the Fitch analysts.
“Management commentary continued to suggest there were no indications of a looming recession,” wrote Taiano and Wolfe.