Tuesday, March 8, 2011

Beige Book Part I; Lending

Last week the Fed issued the Beige Book. This is by far one of my favorite economic publications because it's like getting a complete physical exam of the US economy every 4-6 weeks. The report crawls into all the spaces of the economy and provides great detail about what is going on beneath the surface.

This time around, I'm going to start with lending. First, here are two links (here and here) that examine the latest reports from the FDIC's Quarterly Banking Profile. While the banking sector is clearly on the mend, we're not completely healed yet, meaning the ability to lend -- even in a zero rate environment -- is compromised.

Against that back drop, consider the following from the Beige Book:

Loan demand varied across District and loan category. Richmond, Dallas, and San Francisco noted improvements in overall loan demand, while Kansas City observed a decrease. Demand for residential real estate loans increased in Philadelphia, Atlanta, and Dallas but was weaker in New York, Cleveland, St. Louis, and Kansas City. The New York, Philadelphia, Richmond, Chicago, and San Francisco Districts reported improvements in commercial loan applications. The Dallas District experienced mixed commercial loan demand, while St. Louis noted that demand was unchanged to weaker. Cleveland reported business loan applications were beginning to pickup but demand for consumer loans remained soft. The Philadelphia District expected little change in loan volume as consumers remained reluctant to borrow.

Most Districts reported that credit standards were unchanged to tighter. Kansas City reported standards were unchanged for all types of loans. New York noted some tightening of commercial loan standards but little change in the standards for residential mortgages or consumer loans. The Atlanta District reported increased standards for residential mortgage loans. St. Louis indicated standards had tightened somewhat for commercial mortgages, but were unchanged for C&I loans, and were unchanged to somewhat tighter for residential mortgages. San Francisco noted relatively restrictive standards for both consumer and commercial loans.

Community bankers in the Chicago and Dallas Districts cited increased competition for C&I lending from large banks. Atlanta noted improvements in credit conditions for all loan segments except those related to residential construction and real estate. Cleveland, Richmond, Chicago, Kansas City, and Dallas indicated steady to improving credit quality, and New York reported steady to lower delinquency rates. San Francisco reported that venture capital financing was improving with increased investor interest and IPO activity.

The macro indicators tell us the following:

1.) The BB confirms the healing trend first mention in the Quarterly Banking Profile. Credit conditions are improving and delinquencies are decreasing.

2.) Loan standards are by and large tightening. This is not good for the economy right now, as credit needs to flow. However, considering loose standards helped to create the current mess, the tightening might be good in the long run.

3.) The loan picture is extremely mixed and is highly dependent on loan type and location.

Let's look at the details.

NY: Bankers report a decrease in the demand for residential mortgages, but increased demand for commercial and industrial loans and especially commercial mortgages; demand for consumer loans is reported to be little changed. Bankers indicate no change in the demand for refinancing. Respondents note some tightening of credit standards for commercial and industrial loans, on net, but no change in standards for the other loan categories. Bankers report no change in spreads of loan rates over costs of funds across all loan categories; spreads had been narrowing towards the end of 2010, based on the prior few surveys. Respondents indicate that average deposit rates have been steady to declining. Finally, bankers report a decrease in delinquency rates for commercial mortgages but no change in delinquencies for the other loan categories.

Philly: At most of the Third District banks contacted for this report, total outstanding loan volume has been roughly level since the previous Beige Book. Overall, business loan and residential mortgage volumes outstanding have edged up at commercial banks in the District, but consumer loan volume outstanding has eased. The outlook among Third District bankers interviewed in February is that total loan volume will expand only slightly over the next two quarters. Bankers said that consumers will remain reluctant to borrow until employment begins to improve more steadily and that business firms are still focused on strengthening balance sheets rather than taking on more debt. One banker expressed a view shared by many when he said, "Creditworthy businesses are not looking to borrow."

Cleveland: In general, bankers reported that commercial loan demand was stable or showed modest growth since our last survey. Some bankers commented that demand is strongest from health care providers, small manufacturers, and energy companies. On the consumer side, conventional loan demand remains soft, although a few of our contacts told us that they are seeing a modest pickup. Direct and indirect auto lending continues to show strength, while reports on the use of home equity lines of credit were mixed. Interest rates for business and consumer credit were generally stable. Most of our contacts said that activity in the residential mortgage market has slowed (refinancings and new-purchase originations) due to rising interest rates and seasonal factors. Core deposits continue to grow, with most of the growth occurring in nonmaturing products. The credit quality of businesses and consumer applicants was characterized as stable to improving, while delinquency rates were trending down across most portfolios. Staffing levels have shown little change during the past few weeks. Selective hiring is expected during 2011.

Richmond: Loan demand in the District continued to improve in recent weeks. Several contacts reported that small business lending in particular had increased, with much of the demand coming from capital improvement needs. Demand from medium and large firms was mixed, with some bankers stating that both were requesting more loans, while other lenders' gains were limited to medium-sized businesses. Much of the demand from large businesses was for mergers and acquisitions. A banker in North Carolina noted a marked pick-up in consumer borrowing, mostly with respect to credit card usage, but added that many consumers were paying down debt. A loan officer in Richmond noted a sharp increase in home repair loans. However, several lenders around the District commented on the limited amount of mortgage activity--both for new homes and refinancing. West Virginia continued to lag, with one area banker reporting that loan demand was weak, and the high rate of repayments made sustaining loan volumes difficult. Most bankers were encouraged by recent improvements in credit quality, with several noting that the number of problem loans had declined. Another lender stated that healthy businesses in his area were starting to have more confidence in the recovery and had come back for loans.

Atlanta: District banking contacts reported an increase in mortgage applications in January and early February; most of those attributed the increase in number of applications to refinance activity and lower interest rates. The majority of bankers stated that mortgage lending standards have increased in recent months; while a few bankers reported elevated standards remained unchanged. Small businesses related to construction and real estate in particular, described worsening credit conditions, with many indicating that they either did not receive the amount of credit requested or that they refused the offered credit because of unfavorable terms. Small businesses outside of construction and real estate reported improving credit conditions at community and regional banks.

Chicago: Credit conditions continued to improve in January and early February. With market interest rates rising, financing costs increased, but corporate credit spreads for a number of large firms in the District were slightly improved. Competition for commercial and industrial loans continued to be fierce, and contacts noted an increased presence of large banks in small business lending. Demand for business and consumer credit increased. Much of this continued to be refinancing of existing debt, but core loan demand was noted to be slowly rising. Credit line utilization also picked up, as working capital needs increased. While delinquencies remained elevated, loan quality continued to improve, albeit at a slower pace than during the previous reporting period. Several contacts noted that the banking sector seems to be on its way toward balance sheet repair with earnings improving, and may be starting to turn the corner on lending. Credit availability is beginning to improve for most loan types, although the bulk of lending is still going to the most high quality borrowers.

St. Louis: A survey of senior loan officers at a sample of large District banks showed little change in overall lending activity during the fourth quarter of 2010. During this period, credit standards for commercial and industrial loans remained unchanged, while demand for these loans ranged from unchanged to moderately weaker. Credit standards for commercial real estate loans tightened somewhat, while demand for these loans was moderately weaker. Meanwhile, credit standards for consumer loans remained unchanged, while demand for these loans ranged from about the same to moderately stronger. Credit standards for residential mortgage loans ranged from unchanged to tightened somewhat, while demand for these loans was moderately weaker.

KC: Bankers reported weaker loan demand, increased deposits, and an improved outlook for loan quality in the recent reporting period. Overall loan demand decreased slightly as demand for commercial and industrial loans, residential real estate loans, and consumer installment loans decreased while commercial real estate loan demand edged up. For the fourth straight survey, credit standards remained unchanged in all major loan categories. Loan quality was mostly unchanged from the previous period, while the outlook for loan quality over the next six months improved. Bankers reported increased deposits with gains in transaction and money market accounts.

Dallas: Financial firms report a slight uptick in overall loan demand. Commercial and industrial loan activity remains mixed, but demand for residential real estate loans has picked up from very low levels. Loan pricing is highly competitive, and contacts at community banks report increased competition from larger banks moving "down market" in order to attract new business. Credit quality appears to have stabilized and in some cases is improving. Increased cost of regulatory compliance is restraining lending activity, especially for community banks. Outlooks have improved slightly due to improving credit quality, some deposit run-off, and increased optimism regarding the overall direction of economic activity.

Frisco: Reports from District banking contacts indicated that loan demand was up somewhat compared with prior reporting periods. Although businesses reportedly remained cautious in regard to their capital spending plans, demand for commercial and industrial loans rose a bit. Demand for consumer credit grew modestly as well. A few reports indicated that lenders' willingness to extend credit to small and medium-sized businesses improved in recent weeks, which respondents attributed primarily to perceived improvements in the outlook for existing business plans. Nonetheless, lending standards for consumer and business lending remained relatively restrictive. Venture capital financing showed further signs of improvement, with contacts noting ongoing increases in investor interest and IPO activity.

Here are some observations, in no order of importance:

1.) Credit standards are still very tight, and some districts are tightening further. I'm not sure if this "tightening" is in fact a return to more more prudent lending standards overall, or whether banks are simply keeping a tight reign on lending as their own balance sheets continue to repair.

2.) Overall loan demand is stable to increasing somewhat, but there is not a stampede to obtain loans. Other factors indicate consumers are still repairing their balance sheet, which cuts down on consumer demand for loans, and businesses on the average are simply not trying to obtain credit either.

3.) Several districts noted that larger banks are moving into medium and small bank areas of business as a way to increase their respective bottom lines. This indicates the smaller banks are probably unable to make more of these loans.

4.) Overall, it's interesting to note how little lending there appears to be occurring. Banks are constrained by their balance sheets, consumers are paying down debt and businesses are still concerned about the economy and repairing their respective balance sheets.

5.) Residential loans are still in the doldrums.