Lending standards and terms continue to tighten; demand slows down, July Loan Survey finds

By Sara Rosenberg

New York, Aug. 11 - Domestic institutions further tightened their lending standards and terms on commercial and industrial loans over the past three months, and expect to continue to do so in the second half of this year, and demand for these loans has weakened, according to the Federal Reserve July Senior Loan Officer Opinion Survey on Bank Lending Practices.

Large- and middle-market firms, about 60% of domestic banks, up from about 55% in the April survey, reported that they had tightened their lending standards over the past three months.

On net, about 80% of banks, up from 70%, indicated that they had increased spreads of loan rates over their cost of funds for large- and middle-market firms.

As for small firms, about 65%, up from about 50% in April, of domestic respondents reported tightening their lending standards on such loans over the survey period.

On net, about 70% of banks, up from 65%, noted that they had increased spreads of loan rates over their cost of funds for small firms.

In addition, considerable fractions of domestic respondents reported having boosted non-price-related lending terms on commercial and industrial loans to firms of all sizes over the survey period, and the fraction of banks that tightened such terms on loans to small firms increased significantly relative to the April survey.

Very large majorities of domestic and foreign respondents pointed to a less favorable or more uncertain economic outlook, their bank's reduced tolerance for risk, and to a worsening of industry-specific problems as reasons for tightening their lending standards and terms over the past three months.

Only about 25% of domestic banks, down from 35% in the last survey, reported having tightened their lending standards because of concerns about their bank's current or expected capital position.

As for demand, on net, about 15% of large domestic banks experienced weaker demand from small firms, although about 5% of these banks, on balance, reported that demand from large- and middle-market firms had increased over the past three months.

About 15% of small domestic banks reported weaker demand for loans from firms of all sizes over the survey period.

Substantial majorities of domestic institutions that experienced weaker loan demand cited a decrease in customers' needs to finance investment in plant or equipment as well as firms' decreased need to finance inventories.

In addition, about 65% of domestic respondents pointed to a decrease in customers' needs for merger and acquisition financing as a reason for the lower demand.

Regarding future business, small domestic institutions reported that inquiries from potential business borrowers were about unchanged during the survey period, and about 15% of large domestic banks reported an increase in the number of inquiries from potential business borrowers over the past three months.

A final set of special questions in the July survey asked respondents about their outlook for changes in credit standards at their banks on loans to businesses and households in the second half of 2008 and in the first half of 2009, under the assumption that economic activity progresses in line with consensus forecasts.

Responses to the special set of questions suggested a gradual decline in the fractions of banks tightening lending standards over the next year, with only very few banks expecting to ease standards over that period.

Concerning loans to businesses, about 55% of domestic respondents indicated that they expected their banks to tighten credit standards in the second half of this year, and about 45% anticipated tightening their lending standards on these loans in the first half of next year.

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