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Fed confirms lending standards are tightening

Feb 22, 2023
By: Eric E. VanDoren

The Federal Reserve recently released the results of the January 2023 Senior Loan Officer Opinion Survey and while the results are not surprising, they are certainly noteworthy. Overall, lending standards for most business and consumer loans tightened during the fourth quarter of 2022, with weaker demand reported in almost every category.

Survey respondents cited tighter standards and weaker demand for business loans of all sizes, including commercial and industrial loans as well as commercial real estate loans.

Tightening was most widely reported in the form of premiums charged on riskier loans, spreads of loan rates over cost of funds and costs of credit lines. In addition, there was a tightening of loan covenants and collateralization requirements. The maximum size of credit lines and maximum maturity dates decreased. Respondents noted weaker demand for construction and land development loans as well as loans secured by multifamily properties.

Weaker demand for residential loans

Lending standards tightened or remained basically unchanged across all residential real estate loan types and home equity lines of credit. At the same time, respondents reported weaker demand for all residential real estate loans, particularly home equity lines.

Concerning consumer lending, respondents reported general tightening, particularly for credit card loans. Areas of tightening included higher minimum credit scores and wider interest rate spreads over the cost of funds. Respondents also reported generally weaker demand for auto and other consumer loans, including credit card loans to a lesser extent.

Continued tightening of standards in 2023

The survey also inquired about expectations looking forward in 2023. The expectation is for continued tightening of lending standards along with weakening loan demand. Broad deterioration in loan quality in 2023 is also expected.

The most frequently cited reasons for an expected tightening of standards included an expected deterioration in collateral values, a reduction in risk tolerance and a deterioration in credit quality of loan portfolios.

Weaker loan demand in 2023 is expected as a result of increasing interest rates, expected lower spending or investment needs, expected deterioration in terms other than interest rates, expected easing in supply chain disruptions and an expected decrease in precautionary demand for cash and liquidity.

Credit quality deterioration

A major concern for 2023 revolves around credit quality. Survey respondents expect deterioration in credit quality across all types of loans in 2023, resulting in increased delinquencies and charge-offs. Expected deterioration is specifically a concern for small business loans, syndicated leveraged and nonsyndicated business loans to large and middle-market borrowers, commercial real estate, construction and development commercial loans, consumer nonprime borrowers and residential real estate loans.

Additionally, consumer prime borrowers, syndicated nonleveraged business loans and multifamily loans are also expected to experience loan quality deterioration.

This is a good time to step back and reassess internal lending standards and flexibility in making underwriting policy exceptions for borrowers. Also, consider enhancing annual reviews and stress test credits. Those marginal credits which don’t hold up under stress testing may need additional oversight and ongoing monitoring. Financial institution may benefit from engaging in a more critical third-party loan review.

How Wipfli can help

Wipfli professionals have deep experience helping financial institution clients assess underwriting risks and fine-tune their lending standards. The appropriate policies help build lasting relationships and create a positive impact. Our team’s lending professionals are ready to provide guidance on best practices and help your organization achieve its goals.

Contact us today to learn how your team can gain confidence in the soundness of your lending practices.

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Eric E. VanDoren, CRC
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