Senior Loan Officer Opinion Survey on
Bank Lending Practices

The October 2002 Senior Loan Officer Opinion Survey on Bank Lending Practices focused on changes in the supply of and demand for bank loans to businesses and households over the past three months. In addition, the survey contained three sets of supplementary questions. The first set was designed to clarify the relative effects of supply and demand forces on the rapid runoff in C&I loans over the first nine months of 2002. The second set focused on the extent of cash-out refinancing during the recent boom in mortgage refinancing activity and the behavior of average home prices over the past twelve months. In light of recent declines in bank stock prices and increases in yields on outstanding subordinated debt at some large banks, the final set of special questions addressed changes in banks' cost of funds over the past six months. Responses were received from fifty-five domestic and twenty foreign banking institutions.

The results indicate some further tightening of standards and terms for commercial and industrial (C&I) loans over the past three months. A significant fraction of U.S. branches and agencies of foreign banks continued to tighten both standards and terms. Domestic and foreign institutions reported that the demand for C&I and commercial real estate loans weakened further between the August and October surveys. Domestic banks attribute much of this year's decline in C&I loans to reduced demand from creditworthy borrowers. By contrast, foreign institutions allowed that their own tighter lending standards played an important role.

On the household side, domestic banks reported largely unchanged standards on home mortgages and consumer loans over the past three months. A significant fraction of these banks reported an increase in the demand for home mortgages to purchase homes as well as continued demand for cash-out refinancing. A majority of banks surveyed expect the growth of housing prices in their market area to moderate over the next twelve months relative to the previous twelve month period. Demand for consumer loans was reported to be about unchanged.

Lending to Businesses
(Table 1, questions 1-9; Table 2, questions 1-9)

Commercial and industrial loans. The net percentage of domestic banks that reported having tightened standards on C&I loans to large and middle-market firms over the past three months edged down to 20 percent from 22 percent in the August survey. By contrast, the net percentage tightening standards on business loans to small firms rose from 6 percent in August to almost 20 percent in the current survey, and one bank reported that it tightened standards considerably on these loans.

A similar pattern in lending policies for small and large firms is evident in the number of domestic banks that tightened the various terms listed in the survey. The percentage of banks that raised premiums charged on riskier loans to large and middle-market firms declined from about 50 percent in the August survey to 40 percent in October, while the fraction of banks that reported doing so on loans to small firms increased from one-fifth to more than one-third between the two surveys. In addition, almost 30 percent of respondents indicated that they imposed more stringent collateralization requirements on small firms over the past three months, up from 16 percent, on net, in the August survey. By contrast, the percentage of domestic banks that tightened collateralization requirements on C&I loans to large firms declined from about 30 percent in August to 24 percent in the current survey.

The fraction of U.S. branches and agencies of foreign banks that tightened standards and terms on C&I loans over the past three months retreated somewhat from the elevated range of the previous several surveys. The percentage of foreign institutions that had tightened standards for customers seeking C&I loans or credit lines declined from 60 percent in August to 50 percent in the current survey. In a similar vein, the fractions of foreign institutions that tightened the surveyed terms on business loans over the past three months generally edged down. Between the August and October surveys, the fraction of foreign institutions that raised premiums on loans to riskier customers declined from 80 percent to about 55 percent, and the percentage that reported increasing the cost of credit lines decreased from 65 percent to about 40 percent. By contrast, the fraction of foreign institutions that increased spreads of loan rates over their cost of funds remained at about 70 percent in the current survey.

More than 80 percent of the domestic and foreign banking institutions that tightened standards or terms on C&I loans over the past three months voiced concerns about the economic outlook. Domestic banks continued to cite reduced tolerance for risk and increases in corporate bond defaults as other important reasons for tightening their lending policies. About 70 percent of domestic respondents indicated that reduced tolerance for risk was at least a somewhat important reason for tightening their credit standards and terms, down only slightly from the August survey, and more than one-half of respondents--about the same fraction as in the August survey--identified an increase in corporate bond defaults as a somewhat important reason.

At the same time, industry-specific concerns at domestic banks appear to have eased somewhat, as the percentage of respondents citing a worsening of industry-specific problems as a reason for changing their lending policies declined from 56 percent in August to about 39 percent in October. By contrast, 87 percent of foreign banking institutions cited a worsening of industry-specific conditions as a reason for tightening their lending policies over the past three months. This difference likely reflects foreign institutions' considerably greater concentration of C&I loans to troubled sectors such as telecommunications and high-tech, as evidenced by responses to the August 2001 survey.

On net, 53 percent of domestic banks reported weaker demand for C&I loans from large and middle-market firms in October, up slightly from about 45 percent in August. The net fraction of banks that reported weaker demand from small firms also moved up in the current survey, to about 48 percent. The net percentage of foreign branches and agencies reporting weaker demand for C&I loans over the past three months increased to 40 percent in October from 35 percent in the previous survey.

All but one domestic bank that experienced weaker demand reported that a decline in customers' need for bank loans to finance capital expenditures was at least a somewhat important reason for the weakness in demand, and almost one-half of these respondents chose this reason as "very important." As in the past several surveys, substantial fractions of banks also reported weaker demand for loans to finance mergers and acquisitions, inventories, and accounts receivable. Of the four domestic banks that reported an increase in demand for C&I loans over the past three months, three indicated that the increase was due to a reduction in their customers' internal funds. The most frequently cited reasons for weaker demand at branches and agencies of foreign banks continued to be a decline in merger and acquisition financing and reduced customer investment in plant and equipment.

In an attempt to obtain greater insight into the reasons behind the more than 7 percent annual rate of decline in C&I loans during the first nine months of this year--as reported on the Federal Reserve's H.8 release, "Assets and Liabilities of Commercial Banks in the United States"--banks were asked to rank several possible demand and supply factors. According to domestic respondents, the most important reason for the runoff in C&I loans is the reduced funding needs of creditworthy borrowers; indeed, almost three-fourths of domestic banks identified this factor as being "most important." At the same time, domestic banks indicated that the deterioration in business credit quality has reduced the number of firms viewed as creditworthy, an effect compounded by the reported tightening of lending standards over the past nine months. At branches and agencies of foreign banks, by contrast, reduced demand from creditworthy borrowers was not deemed nearly as important. Almost all foreign institutions reported that the recent drop in C&I lending resulted from a reduction in the number of creditworthy borrowers, but the respondents were almost evenly split between those that attributed the reduction to a general deterioration in borrowers' credit quality and those that attributed it to the imposition of more stringent lending standards. In a follow-up question, 55 percent of domestic banks, on net, and 65 percent of foreign institutions indicated that the rejection rate on C&I loan applications was higher over the first nine months of 2002 than over the corresponding period in 2001.

Commercial real estate lending. The fractions of domestic and foreign banking institutions that reported tighter standards on commercial real estate loans over the past three months stayed at about 25 percent and 30 percent, respectively, in the October survey. Demand for commercial real estate loans continued to weaken on net. The net fraction of domestic banks reporting weaker demand for commercial real estate loans was about unchanged between August and October at about one-third. At foreign institutions, the net fraction of respondents experiencing weaker demand for commercial real estate loans over the past three months rose from 18 percent in August to 36 percent in the current survey.

Lending to Households
(Table 1, questions 10-23)

Ten percent of domestic banks reported that they had tightened lending standards on residential mortgage loans over the past three months, the highest share in the past decade. On net, 40 percent of respondents reported increased demand for residential mortgages, up from 27 percent in the previous survey, a result consistent with the elevated level of new home sales between the two surveys.

A set of supplementary questions addressed changes in home appraisal policies, the extent of cash-out mortgage refinancing, and trends in home prices. Almost all domestic banks indicated that their policies concerning the appraisal of home values for mortgage loans--for loans they intend to hold on their books--have remained essentially unchanged over the past six months; four of the five remaining respondents indicated that they had become somewhat more conservative when appraising home values.

This year has seen record levels of home mortgage refinancing. Reportedly, many households also increased their loan balances at the time of refinancing, an arrangement sometimes referred to as cash-out refinancing. Almost half of domestic respondents in the October survey indicated that between 20 percent and 40 percent of the customers that refinanced their mortgages over the last six months engaged in cash-out refinancing; about one-fifth of banks reported that more than 40 percent of these customers did so. These percentages are appreciably higher that those reported in the January 2002 survey, which contained a similar question.

For customers who increased the outstanding balance of their mortgage when refinancing, about 70 percent of banks reported that the typical increase was between 5 percent and 15 percent of the original outstanding balance. More than 25 percent indicated that the typical increase, again as a percentage of the original outstanding balance, was greater than 15 percent. These numbers suggest some increase in the amount of cash-out refinancing when compared with the January 2002 survey, in which only 20 percent of banks indicated that the typical increase in the outstanding balance was greater than 15 percent. In the current survey, domestic banks reported that their customers' most common use of funds from cash-out refinancing was to repay other debt and to pay for home improvements, essentially the same as in the January 2002 survey.

Domestic banks were also queried about the behavior of average home prices in their markets over the past twelve months. About three-quarters of these institutions reported that the average home price in their market has increased over the past twelve months; in fact, about 15 percent of respondents indicated that the increase was substantial. However, many banks expect these increases to moderate or partially reverse over the next twelve months. About a fifth of banks anticipate a decrease in average home prices in their respective markets, while only about a third forecast a further increase, and no bank expects that increase to be substantial.

In the October survey, about 15 percent of domestic banks indicated that they had tightened standards on credit card loans and other consumer loans over the past three months, about the same as in the previous survey. Over the same period, almost one-quarter of respondents reported reducing the number of exceptions granted to customers not meeting credit-scoring thresholds on all consumer loans. For the second consecutive survey, a small net fraction of domestic banks reported that demand for consumer loans was somewhat weaker over the past three months.

Changes in Cost of Funds
(Table 1, questions 24-25; Table 2, questions 10-11)

In light of recent declines in bank stock prices and increases in yields on subordinated debt at some banks, the last set of special questions focused on changes in banks' cost of funds over the past six months. About 30 percent of domestic banks reported that their weighted-average marginal cost of funds--relative to the marginal return on their assets--decreased slightly over the past six months, while 13 percent of respondents acknowledged a slight increase in their relative marginal cost of funds. Only two domestic banks reported that their relative marginal cost of funds has increased moderately or significantly over the past six months. Domestic institutions that experienced an increase in their marginal cost of funds reported that, in response, they raised their loan pricing terms such as fees and spreads. Domestic institutions that reported a decrease in their marginal cost of funds, by contrast, were able to reduce fees and spreads. On net, about 20 percent of foreign banks indicated that their weighted average marginal cost of funds had increased slightly relative to the marginal return on their assets.

The charts and tables for this report are available in Acrobat (PDF) format. Obtaining the Acrobat Reader

Charts (12.5 KB PDF)
Measures of lending practices from current and previous surveys
Chart data (ASCII)

Table 1 (27.1 KB PDF)
Summary of responses from U.S. banks

Table 2 (13.9 KB PDF)
Summary of responses from branches and agencies of foreign banks

Full report (116 KB PDF)