Lending Latitudes

The horse latitudes often refer to a section of the Atlantic ocean where there was little wind for a period of time, causing sailing ships to get “stuck” in the middle of the ocean.  There are two winds that drive a developed economy like that in the U.S – the demand for loans and the willingness of banks to make those loans.

Every 3 months the Federal Reserve Board (FRB) interviews a number of bank loan officers on their lending practices, risk management of and demand for commercial, industrial, mortgage and consumer loans.  The latest October 2010 survey  shows small increases in demand for commercial and industrial loans.

In questions 11 and 12 of the survey, loan officers were asked about residential mortgages. Demand for prime mortgages remains relatively unchanged.  34 loan officers responded that they do not originate non-traditional mortgages like interest-only or no income verification.  There were so few responses to questions about sub-prime mortgages that the FRB did not list the results.  If you anticipate being in the market for a mortgage in the coming years, you can conclude that it will be difficult to find a non-traditional or sub-prime mortgage.

Loan officers surveyed saw little overall change in demand for home equity lines of credit but a quarter of them said that they had tightened slightly their lending standards for these types of loans and 12% said that they had lowered existing lines of credit.

Consumer credit was largely unchanged but there was a hopeful sign for businesses.  Over 25% of smaller banks reported that they had increased business credit card limits.  The signs were not so hopeful for those in commercial construction as 20% of officers reported that they had decreased lines of credit for their existing customers and half of respondents anticipate that their lending standards for commercial construction will remain tighter for the foreseeable future. 

For consumers and homeowners the future does not look rosy.  The survey includes a category called the “foreseeable future”, not just the next two years, when asking loan officers about their anticipated lending standards.  40% of loan officers anticipate tighter standards for residential construction and 34% foresee tighter standards for prime mortgage homeowners (62% for sub-prime holders) wanting to borrow money against the equity in their house. Over half of loan officers see the same tightening for credit card and other consumer loans. 

Big box stores like Home Depot and Lowe’s that depend on remodeling and construction dollars have seen a 10%+ increase in their stock prices the past month.  Given the current lending environment, it may be difficult for these companies to maintain the sales growth that justifies the expectations implied by such a dramatic stock price increase.  The reluctance to lend will continue to suppress growth in the consumer market which accounts for over 2/3 of this country’s GDP. 

Easy Money

A Future of Finance article in a December 2009 Financial Times quoted a partner at a leading London law firm: “There are huge piles of toxic debt on these [bank] balance sheets but much of it isn’t being recognized. Loans are being rolled over. There is a saying in banking circles now that ‘a rolling loan gathers no loss'” The same article also quoted Raymond Baer, chairman of Swiss private bank Julius Baer, who warned: “The world is creating the final big bubble. In five years’ time, we will pay the true price of this crisis.”

In a WSJ op-ed 10/16/09, Ann Lee, a former investment banker and hedge fund partner, writes that banks are hoping that by rolling over the loans at negotiated terms borrowers will eventually be able to make payments. She predicts that this cycle of rolling debt, reminiscent of what happened in Japan during the 1990s, could continue for a decade. With so much unrecognized bad debt, banks have little incentive to increase their lending. Instead, they borrow from the Federal Reserve at near zero interest rates and use the money to buy Treasury bonds, pocketing the difference in interest rates as profit. Since Treasury bonds are taxpayer IOUs, taxpayers are effectively subsidizing the profits of Wall Street banks. Ben Bernanke, head of the Federal Reserve and chief architect of this subsidy scheme, was recently reappointed by President Obama.

In late November, Standard & Poors released their analysis ranking of 45 leading banks in the world, using a new risk adjusted capital ratio (RAC), which will probably be adopted in 2010. This ratio gauges a bank’s leverage of assets to equity with greater attention paid to the risks of those assets than the current Tier 1 capital ratio does. According to this more rigorous metric, banks like Japan’s Mizuho and Sumitomo Mitsui, Citigroup, and Switzerland’s UBS have a particularly weak capital base. Just nine of the 45 banks rated by S&P had an adequate risk adjusted capital.