Lending terms continue to ease; demand is flat, October Loan Survey finds

By Sara Rosenberg

New York, Oct. 30 - Domestic banks continue to ease lending terms on commercial and industrial loans, but many of these banks are seeing little change in demand for loans, according to the Federal Reserve October Senior Loan Officer Opinion Survey on Bank Lending Practices.

Over the past three months, domestic respondents indicated that they had further eased terms on loans, with almost one-third of respondents saying they had trimmed spreads, about one-fifth saying they had reduced the costs of credit lines and about 15% indicating that they had eased covenants.

However, domestic institutions said that credit standards on commercial and industrial loans to large and middle-market firms were unchanged.

Credit standards on loans to small firms were reportedly little changed, on balance, in the October survey. But, about one-third of banks did indicate that they had trimmed spreads of loan rates and nearly one-fifth of respondents noted that they had reduced the costs of credit lines.

More aggressive competition from other banks or nonbank lenders was named as a prime reason for eased standards or terms by all respondents.

Notable net fractions of domestic institutions also cited increased liquidity in the secondary market for these loans, a more favorable or less uncertain economic outlook and a reduction in defaults as reasons for having eased credit standards or terms.

On balance, demand for commercial and industrial loans from large and middle-market firms were reportedly little changed in the October survey at domestic institutions.

Domestic institutions that experienced weaker demand attributed the softening to borrowers' decreased needs to finance investment in plant or equipment, borrowers' decreased financing needs for inventories and accounts receivable, and increases in customers' internally generated funds.

Domestic institutions that experienced stronger demand attributed the gain to a rise in merger and acquisition activity and increased needs to finance inventories.

Regarding future business, about 10% of domestic institutions reported that the number of inquiries from potential business borrowers had decreased moderately over the previous three months.

The October survey included a set of special questions about the extent to which the recent strength in commercial and industrial lending has reflected a surge in loans to fund M&A activity.

Holdings of loans originated for M&A-related purposes were generally small for the respondent banks, with about one-half of domestic institutions indicating that M&A-related loans accounted for less than 5% of the loans currently on their books, roughly one-third of banks indicating that such loans accounted for between 5% and 10% of their loans and the remainder banks indicating a share that was between 11% and 30%.

On average, those banks with larger loan portfolios had higher M&A loan concentrations.

Nearly one-half of domestic respondents reported that the share of M&A-related loans on their books had increased over the past 12 months.

Among the domestic institutions that experienced an increase in the share of M&A-related loans over the past 12 months, about one-third indicated that this increase reflected to a moderate extent a shift of funding for M&A activity to banks as a result of a reduction in the relative attractiveness of bond finance. Eighty percent of these institutions pointed to relatively more favorable nonprice terms as a reason for the shift of M&A financing out of the bond market, while 60% pointed to relatively more favorable pricing in the loan market.

On balance, about 15% of domestic institutions reported that they had tightened credit standards for approving applications for M&A-related loans or credit lines over the past 12 months. These respondents, however, indicated that they had eased some terms on such loans or credit lines over the same period, including lowering spreads and reducing the cost of credit lines.

About one-fourth of domestic respondents indicated that they anticipate that the quality of M&A-related loans currently on their books will deteriorate over the next 12 months, and the rest expect that loan quality will likely stabilize around current levels.

About 35% of domestic respondents reported that they expect the quality of their loans that were not used to finance M&A activity to deteriorate over the same period.

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