Midsize banks are tightening up their underwriting on business loans as they worry a bit more than large banks about liquidity and funding costs, according to a new Federal Reserve survey of senior bank loan officers.
The survey was closely watched since it follows the recent turmoil in the banking industry, which has prompted concerns that a pullback in bank lending could slow economic growth.
Banks were already taking a more cautious approach to underwriting heading into this year, a trend that continued in the first quarter. The tightening was more noteworthy for business loans at midsize banks, which the Fed survey defined as those holding between $50 billion and $250 billion of assets.
“In general, the tightening in standards for business loans was more frequently reported across the mid-sized banks than either the largest banks or other banks,” the Fed said.
The survey, conducted in late March through early April, found that midsize banks and smaller ones “reported concerns about their liquidity positions, deposit outflows, and funding costs more frequently than the largest banks,” helping explain their pullback.
Overall, the net percentage of domestic banks that tightened standards for commercial and industrial loans was 46%. That was up slightly from the prior quarter but marked a significant reversal from 2022, when far more banks were easing standards than tightening them.
The industry expects further tightening across all loan categories for the remainder of the year, according to the survey. Sixty-five domestic banks and 19 U.S. divisions of foreign banks responded to the survey.
“Banks most frequently cited an expected deterioration in the credit quality of their loan portfolios and in customers’ collateral values, a reduction in risk tolerance, and concerns about bank funding costs, bank liquidity position, and deposit outflows as reasons for expecting to tighten lending standards over the rest of 2023,” the Fed said.
But given the significant pullback over the last year, the overall figures didn’t move much, according to Brandon King, a bank analyst at Truist Securities.
“This suggests that while standards continue to tighten, there appears to be no outsized shock from recent events and a continuation of the tightening trend since last year,” King wrote in a note to clients, adding that “fears of a substantial credit crunch may be misplaced.”
The data showed “a more modest tightening of lending standards than feared,” Matthew Luzzetti, chief U.S. economist at Deutsche Bank, wrote in a note to clients.
The survey results line up with recent commentary from bankers, many of whom have shared they’ve gotten pickier on the loans they’re making and taking less risk. The more stringent approach is particularly noticeable in areas that either boomed during the pandemic or came under trouble, such as auto lending or commercial real estate.
Executives at Citizens Financial Group “feel really good about where we stand right now” in their consumer loan book, Brendan Coughlin, the Providence, Rhode Island-based bank’s head of consumer banking. But it has “tightened a bunch in the last 6 to 9 months just as a cautionary measure,” he added.
“We’ve made credit tightenings, not because we’re seeing anything we don’t like, just in an abundance of caution to make sure that we don’t have any tail risk in any of the portfolios,” Coughlin said on the bank’s quarterly earnings call last month, according to an S&P Global Market Intelligence transcript.
Banks are also seeing less demand for most loans, the survey indicated. While banks are implementing tighter standards for business and CRE loans, they are also seeing weaker demand from customers for both, the survey found.
In C&I loans, for example, the net percentage of banks reporting stronger demand fell to -55.6%, indicating far more banks saw weaker demand during the quarter. The picture looked far different in the third quarter of 2022, when the net percentage of banks reporting stronger demand was 24.2%.
Demand also weakened for residential real estate loans, home equity lines of credit and auto loans, though it “remained basically unchanged for credit cards,” according to the survey.
“I think both the bank and our clients are taking a more conservative approach,” Christopher Bagley, president at Tupelo, Mississippi-based Cadence Bank, said on an earnings call last month. Higher interest rates and uncertainty over the economic outlook are dampening demand, he said, according to an S&P Global Market Intelligence transcript.
Fed Chairman Jerome Powell previewed the results of the survey last week, saying they were “broadly consistent” with moderation in lending activity that the Fed has been seeing for months. But he also said recent strains in the banking system “appear to be resulting in even tighter credit conditions” that are likely to weigh on the economy.
Those effects remain “uncertain,” and the Fed will “continue to very carefully monitor” trends in the banking system as it decides on interest rates, he said.
Fed officials raised their benchmark rate to between 5% and 5.25% at their meeting last week, though Powell hinted at a pause in rate hikes when they meet again in June.