This Week’s Fed Lender Survey: Is the Glass Half Full? Or Half Empty?

Signs of Gradual Healing Continue in Lending Sector

While all of us were all settling into our work weeks after another summer weekend, the Federal Reserve released its much-anticipated July 2014 Senior Loan Officer Opinion Survey on Bank Lending Practices*. This quarterly survey queries bank officers on the status of lending standards—and demand—for all types of bank loans, including commercial real estate loans, over the prior three months. So, is the glass half-full or half-empty? That all depends on your perspective.

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The media latched onto headlines that the survey showed a broad-based uptick in loan demand and more relaxed lending standards in the second quarter after a slow start to the year. But what’s the story specific to commercial real estate lending? This brief summarizes EDR Insight’s analysis of the raw results, isolating those responses specific to commercial real estate lending (which the Fed categorizes as follows: construction/land development, multifamily and nonfarm/nonresidential).

Demand for CRE Loans Stable to Rising…

Despite the rosy headlines, the results for commercial property lending paint a slightly different picture. Most banks (approximately three out of four) reported having experienced about the same level of demand for all three major categories of commercial real estate loans over the April-June time period.

Fed1Construction/land development loans were associated with the highest percentage of respondents (33%) experiencing stronger demand in the second quarter over the first. This is not surprisingly given the strong interest developers have shown in purchasing properties while land prices and construction costs are still relatively low. The percentages of bank respondents seeing higher demand for nonfarm/nonresidential and multifamily loans were not far behind at 24 and 23 percent, respectively. And notably, for all three loan types, an insignificant percentage reported weaker loan demand in the past quarter.

…Loan Standards Holding Firm

The story is essentially the same in terms of lending standards. It makes for more dramatic headlines to say standards are eroding, yet the results show that for commercial real estate lending, the majority of banks are holding firm. In the survey, the Fed explored changes in lending standards in two ways, one short-term, one long-term:

1.    Over the past three months, how have your bank’s credit standards for approving new applications for these types of loans changed?

Across all three loan categories, 85 percent report that their lending standards remain unchanged compared to the first quarter. Credit standards are more stringent than they were before the 2008 financial crisis, and banks report still-high underwriting standards.

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2.    The July survey included a set of special questions that asked respondents to describe the current level of lending standards at their bank, considering the past nine-year period as follows: Using the range between the tightest and the easiest that lending standards at your bank have been between 2005 and the present, how would you describe your bank’s current level of standards relative to that range for each loan category?

Over the longer time frame, banks participating in the July survey reported having eased standards, but there was significant variability by loan type. On average, one in three reported that their current level of standards on loans secured by these three types of commercial properties is easier relative to the post-2005 norm. Multifamily properties were associated with the highest percentage (37%) reporting an easing of standards. However, nearly half of the respondents reported that standards on construction and land development loans were tighter than the midpoints of their longer-term ranges and few had eased standards on these types of loans. On multifamily and nonfarm/nonresidential, about half kept loan standards unchanged compared to the nine-year norm. Thirty-seven percent reported easing standards for multifamily, the favored asset class, and 32 percent eased standards for nonfarm/nonresidential loans.

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For banks that were easing standards, more aggressive competition from other lenders was most commonly cited as the reason (more so than market uncertainty or a higher risk tolerance). Aggressive competition from other lenders in a slow-growth, low-interest-rate environment is driving some institutions to relax their standards in order to stay competitive. Compared with the results in the July 2013 survey, this year’s results indicate an easing of credit conditions for all three types of commercial real estate loans from the corresponding levels reported a year ago.

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The bottom line is that on both sides of the equation (loan demand and stringency of lending standards), the Fed’s latest results point to continued gradual healing in the commercial real estate lending sector. Reports of stronger demand continue to outnumber reports of weaker demand, and loan growth is stronger than it was a year ago (good news). Also, only a modest net fraction of respondents had eased standards on commercial real estate loans in the latest quarter (also good news). However, the longer-term trend suggests that a gradual easing is underway (not-so-good news).

It is noteworthy that the Fed survey was conducted in early July, in the midst of recent warnings from the Office of the Comptroller of the Currency over eroding underwriting standards among lenders. Signs of a gradual easing of standards are perhaps not surprising given the current competitive climate, but for environmental due diligence professionals with clients in the lending space, this early trend emphasizes the importance of educating risk managers at financial institutions about the value of solid environmental due diligence, both to demonstrate to regulators that risk is being managed and to protect the value of collateral on commercial real estate loans.

*ABOUT THE SURVEY

Respondent banks (75 domestic and 23 foreign banks operating in the U.S.) received the survey on or after July 1, 2014, and responses were due by July 15, 2014. The questions cover all types of lending: commercial & industrial, commercial real estate, consumer and residential. The full survey is available here. The next survey will be released in early October.