Eye On Housing
Lending standards on business loans to large and medium-sized firms eased on net over the second quarter of 2017 according to the Federal Reserve Board’s Senior Loan Officer Opinion Survey. Historical evidence has shown that lending standards on business loans to these establishments is correlated with both the growth in the stock of business loans held by banks and with real gross domestic product (GDP). At the same time, growth in the stock of business loans held by banks is related to a declining unemployment rate. As a result, information gleaned from lending standards on commercial and industrial loans can signal the onset of a recession.
The Federal Reserve Board’s Senior Loan Officer Opinion Survey (SLOOS) addresses changes in the standards and terms on, and demand for, bank loans to businesses and households over the past three months. The Survey can be used by housing analysts to analyze the evolution of standards on and demand for mortgage loans as well as commercial real estate (CRE) loans. The survey can also be used to assess the future of economic growth and the labor market by assessing changes in standards on commercial and industrial (C&I) loans. According to the FDIC, the stock of C&I loans represents the second largest category of net loans and leases on aggregated bank balance sheets.
The figure above compares net tightening of lending standards by banks on C&I loans to large and middle-market firms with both the quarterly change in C&I loans held by banks and with the presence of a recession, the grey shaded region. In the second quarter of 2017, the most recent quarter for which data is available, a net share of 3.9 percent of banks eased standards on C&I loans.
Over a longer time frame, periods when net lending standards on C&I loans exhibited sustained tightening coincide with periods when growth in the stock of C&I loans slowed and ultimately began to contract. At the same time, both the 2001 recession and the most recent Great Recession were preceded by tightening in lending standards on C&I loans. This relationship was demonstrated by research finding that “fluctuation in commercial credit standards are highly significant in predicting commercial bank loans, real GDP, and inventory investment in the trade sector”. Additionally, recent analysis by economists at the Federal Reserve Bank of New York suggests that lending standards on C&I loans are negatively correlated with the change in real GDP and not just the presence of a recession.
Periods of growth in C&I loans, which are determined in large part by the underlying standards for these loans, coincide with a falling unemployment rate. In addition, sustained deceleration or an outright decline in the C&I loans coincides with periods when the unemployment rate rises. One interpretation is that growth in business investment, partly stemming from easier lending standards on business loans, spurs firm spending and raises total output (real GDP). Economic growth coincides with an expansion in the number of jobs throughout the economy, lowering the unemployment rate (an application of Okun’s Law).
In the second quarter of 2017 iteration of the SLOOS, senior loan officers were also asked to describe their banks’ current level of standards on a variety of business and household loans “using the range between the tightest and the easiest that lending standards at your bank have been between 2005 and the present”. The standard questions that obtain information about lending standards compare current standards relative to the most recent quarter, but the wording of this question is meant to elicit information on lending standards relative to a longer period of time and is often interpreted in absolute terms (“easy” v. “easier” and “tight” v. “tighter”)
The figure above compares C&I loans with another large category of business loans, CRE loans. In the second quarter of 2017, C&I loans accounted for $1.96 trillion of banks’ aggregate held net loans and leases while construction and land development, non-farm nonresidential and multifamily permanent loans combined accounted for $2.06 trillion. While lending standards across various kinds of C&I loans are easy relative to the range of standards since 2005, standards across CRE loans are considered tight. Net lending standards are tighter on both construction and land development loans and multifamily permanent loans relative to the range of standards recorded on these loans since 2005.
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