Results from the most recent iteration of the Federal Reserve Board’s Senior Loan Officer Opinion Survey (SLOOS), covering the first quarter of 2017, indicates that demand for both multifamily and construction and land development loans continued to weaken while lending standards on these loans continued to tighten. Construction and land development loans include both residential construction loans, about 20 percent, and all other construction and land loans, approximately 80 percent, while multifamily loans refer to mortgages or other liens secured by multifamily residential properties but exclude loans for multifamily residential property construction.

The most common policy along which banks tightened was charging a higher interest rate relative to the bank’s cost of funds, but a significant net portion of banks also reported tightening by requiring a lower loan-to-value ratio or higher debt service coverage ratio. Of those that tightened lending standards across the predefined menu of policies, a large proportion of banks cited concerns about vacancy rates, property prices, cap rates, and reduced risk tolerance as important reasons for tightening their standards.

Each quarter, the SLOOS asks bank loan officers to document changes in lending standards and demand for specific loan products. The extent of tightening or easing in lending standards is measured by subtracting the percent of banks reporting that standards had eased at their bank from the proportion saying that standards had tightened. A similar calculation is done to measure the net percent of banks reporting stronger or weaker demand. The SLOOS typically includes “special questions” aimed at shedding additional light in the financial system or broader economy. The special questions posed by the SLOOS this time focused on CRE lending.

As shown in the figure above, lending standards on multifamily residential debt remained tight on net in the first quarter of 2017 and the net proportion of banks tightening standards exceeded the percentage in the fourth quarter of 2016. However, the net percent tightening standards remains below its peak level in the second quarter of 2016.

At the same time, bank loan officers’ perceptions of demand for multifamily residential debt continued to deteriorate. In the first quarter of 2017, 8.3 percent of banks on net reported that demand for these loans had weakened over the quarter, more than (mathematically less than) the 7.2 percentage of banks on net that reported weakened standards in the fourth quarter of 2016.

The narrative told by trends in supply and demand for construction and land development loans is similar. However, previous NAHB analysis highlighted that only about 20 percent of the stock of construction and land development loans on bank balance sheets is 1-4 family residential construction. Lending standards tightened on net over the first quarter of 2017 and the pace of tightening accelerated from its fourth quarter of 2016 level. However, at 32.4 percent, the net portion of banks tightening standards in the first quarter is the highest on record.

Demand for construction and land development loans continues to weaken on net. In the first quarter, a net of 9.8 percent of banks reported that demand at their bank had weakened. The current proportion of banks reporting net weakening in demand for construction and land development loans is the lowest on record. However, the history of these series excludes the most recent recession.

Results from the special questions posed by the SLOOS add greater specificity to the policies along which banks reported tightening. As shown in the figure above, the largest net proportion of banks reported raising interest rates, relative to the bank’s cost of funds, on both multifamily residential loans and construction and land development loans.  On multifamily residential loans, more than 10 percent of banks on net reported also tightened by requiring lower loan-to-value ratios, higher debt service coverage ratios, reducing the markets served or shortening the interest only period. For construction and land development loans, more than 10 percent of banks on net reported tightening loan-to-value ratios and debt service coverage ratios.

Of banks that tightened any of the 7 policies shown in the figure above, the SLOOS then asked which reasons, from a set menu, were most important for the change. More than half of the banks tightening one or more policy identified vacancy rates, CRE property prices, cap rates, and reduced risk tolerance as either “somewhat important” or “very important”. Meanwhile, regulatory changes, capital adequacy, and decreased ability to securitize CRE loans were generally “not important” reasons for tightening standards*.

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* Specifically the reasons are:

Less favorable or more uncertain outlook for vacancy rates and other fundamentals

Less favorable or more uncertain outlook for CRE property prices

Less favorable or more uncertain cap rates

Less aggressive competition from other banks or nonbanks financial institutions

Increased concerns about the effects of regulatory changes or supervisory actions

Increased Concerns about bank’s capital adequacy or liquidity position

Decreased ability to securitize CRE loans