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The Credit Environment for Business Loans

A major concern arising out of credit market impairments is that businesses, which rely on credit for operations and growth, may find it difficult to receive new loans or refinance existing ones. Some reports have shown evidence of contraction in commercial and industrial (C&I) loans, usually using loan volume data. We look at some other measures of business lending, based on Call Report, FDIC, and Federal Reserve survey data, to analyze supply and demand patterns for these loans.

Loans to businesses come in two primary forms: lines of credit that can be tapped for cash management and working capital, and term loans meant for business expansion. Both are important for the smooth functioning of businesses, particularly at times when financial market and economic conditions are strained. Consider that in an illiquid market environment, a firm or entrepreneur might want both a backup credit line for liquidity and a term loan to finance the purchase of, for example, a business line that a troubled competitor is selling off.

FDIC data show that commercial and industrial loan volume experienced significant growth from 2006 to mid-2007, but then fell off sharply with the onset of the recession in 2008. A shrinking C&I loan volume does not, however, mean that all commercial credit is contracting. The type of commercial credit outstanding has shifted somewhat to credit line draw-downs. In addition, a decline in the overall demand for C&I loans has reduced loan volumes.

Quarterly Change in C&I Loan Volume

Commercial credit-line utilization rates have exhibited a very different trend from the loan volume numbers. As banks grew more cautious about extending term loans, businesses opted to increase draw-downs on existing credit lines from banks. Since 2007, utilization rates as a percentage of extended commitments have risen nearly 7 percent.

C&I Credit Line Utilization Rate

According to some recent reports, banks have been shortening the maturity term of their business loans, adding stricter covenants, and generally tightening credit standards. Relative tightening in C&I markets can be analyzed using the Fed’s Senior Loan Officer Opinion Survey, which collects information about credit markets from bank lenders each quarter. Their responses can be used to gauge the supply of and demand for credit.

The data from the survey show that fewer banks have tightened their credit standards for business loans in the first quarter of 2009 compared to the end of 2008. As of the first quarter of 2009, the net percentage of banks reporting tighter standards (those tightening minus those loosening) was approximately 40 percent. That is, the fraction of banks still tightening has fallen. This reduction applies to commercial loans that have been extended to both small firms and medium-to-large firms, and as such it indicates a broader-based reduction in tightening across the banking sector.

Banks Reporting Tighter Credit Standards

The survey also shows that about 80 percent of domestic banks continued to increase interest rate spreads on loans to medium and large businesses (about 75 percent bumped up spreads for small firms as well). But although a large majority of banks are still widening interest rate spreads beyond their cost of funds, the practice is somewhat less pervasive than during the previous two quarters. Banks partially attributed the net tightening of standards and loan terms to “a less favorable or more uncertain economic outlook, a worsening of industry-specific problems, and a reduced tolerance for risk.”

Demand is the other half of the picture. The demand for business loans shows a dramatic fall-off since the end of last year. Most recently, 60 percent of bank respondents told the Federal Reserve that they were seeing weaker demand for business loans from firms of all sizes. Loan officers attributed the weaker demand primarily to “a decrease in [the need] to finance investment in plant or equipment...inventories, accounts receivable, and mergers and acquisitions.” Simply put, fewer economic opportunities mean lower demand for credit. Another possibility is that the restrictive credit standards of banks, combined with the degraded balance sheets of a large fraction of firms, are leading many businesses to assume that they cannot get credit on favorable terms, and consequently they do not approach financial institutions for new loans or credit lines.

Banks Reporting Stronger Loan Demand

Finally, we compare Fourth District banks to the larger domestic banking sector. To avoid the swings in loan volumes by the largest banks, we limit our sample to only those banks with less than $15 billion in total assets. We find that Fourth District banks of this size realized, at the aggregate level, a return on total assets of 0.19 percent last quarter, down from 0.78 percent in the fourth quarter of 2008. At the national level (which includes the Fourth District banks), net income for institutions with under $15 billion in assets was negative, resulting in an ROA of -0.005 percent. Gross returns on commercial loans were identical regionally and nationally, at 1.38 percent. And although C&I charge-offs fell between the fourth quarter and first quarter, commercial loans that were past due or no longer accruing interest continued to creep up during this period for all banks, including those in the Fourth District.

Aggregated Bank Commercial Loan Statistics

Indicator 2008:Q4 2009:Q1
Fourth District banks All U.S. banks Fourth District banks All U.S. Banks
Return on total assets (percent) 0.78 0.10 0.19 −0.005
C&I interest income to total C&I loans (percent) 7.24 6.38 1.38 1.38
C&I charge-offs (as a percentage of C&I loans) 0.79 1.03 0.26 0.39
C&I past-due and non-accruing loans (as a percentage of C&I loans) 2.64 2.21 3.00 2.78

Note: Excludes banks with more than $15 billion in assets.
Source: Bank Call Reports.

The data we have considered indicate that business loan volumes continue to exhibit a downward trend, though firms are still drawing heavily on credit lines that may have been established before the tighter credit cycle. And while loan officers are reporting some easing of the credit supply, demand for business loans remains low and may result in continuing C&I volume contraction at the aggregate level. Going forward, increasing C&I loan volume, a continuing loosening of credit terms, and a return of business loan demand will serve as indicators that credit markets and the real economy are returning to health.

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