It's Getting Harder to Get a Loan
Why? And what does it mean for borrowers going forward?
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It is not as easy to get a loan today as it was a year ago. Banks are tightening up, and the implications are significant for borrowers, businesses, and the overall economy. Why are banks saying no to financing requests more and more often these days? And what does it mean going forward? Let’s dig in.
Standards Tightening Across the Board
First and foremost, it is harder to get a loan these days because interest rates are so much higher now than they were last year. Some deals that would have cash flowed positively based on 2022 (or earlier) interest rates simply do not work today, and therefore loans for those projects are not happening.
But bankers are also worried about non-interest rate variables and, indeed, lending standards have tightened in 2023 for all categories of loans: residential, commercial, auto, and consumer (including credit cards). Standards are getting particularly tight for commercial loans. This is according to the latest Federal Reserve Survey of Senior Loan Officers, which recently reported data to back up what local loan officers like me are seeing on a regular basis: tighter underwriting and a greater frequency of declined requests.
On the commercial side, nearly half of those bankers surveyed reported tighter standards while not a single respondent said that standards at their banks were loosening. Underwriting for construction and development loans has become particularly stringent, with 74% of those surveyed reporting tighter standards for these types of loans (note: there is some slight variability between standards for large, middle, and small business borrowers, but not enough to make a meaningful difference; the data is pretty similar across all types of businesses). Of particular note to rental property owners, the survey showed that 68% of senior loan officers are reporting tighter lending standards for multifamily residential properties, making it harder to get loans for these types of properties. The combination of tightening on both construction loans and multiunit rentals is unfortunate in many ways given the nation’s housing crunch, although as I’ve written about recently, multiunit construction has remained pretty strong despite the tighter lending standards.
Standards for residential home loans have not tightened quite as much as for commercial loans, with just 9% of respondents saying standards have tightened for GSE-eligible home loans (i.e. Fannie and Freddie loans); in fact, 7% of respondents actually said standards for home loans in this category were loosening. 15-20% of respondents said that standards were tightening for non-GSE home loans, however, including jumbo mortgages (over $726,200). 33% of respondents said standards are tighter for subprime mortgages and 29% said standards were tighter for HELOCs. About 30% of bank senior loan officers report tighter standards for credit cards and auto loans.
So what’s going on? Are bankers just particularly curmudgeonly these days? That may actually be true in some places, but in fact there are several key variables at play:
THE ECONOMY
As James Carville, advisor to presidential candidate Bill Clinton, said in 1992, “It’s the economy, stupid.” 94% of 48 senior loan officers surveyed by the Federal Reserve noted that concerns about the health of the economy were either a somewhat or very important variable in tightening their lending standards. Only 3 out of 48 said it was not important. Bankers are worried about an economic pullback that could put its borrowers in peril and, therefore, make them delinquent on loan payments or default on loans altogether, which would result in losses for the bank.
SPREADS
One thing that has greatly impacted banks’ standard business practices in the past six months is the rapidly rising cost of deposits. For much of the last decade, interest rates on checking and savings accounts, money market accounts, and CDs were virtually 0%. Banks have not needed to pay for deposits until recently. But now with rising interest rates, deposit rates are going up too. Competition for deposits is fierce not just between banks, but also with the Vanguards and Fidelitys of the world who do not operate brick and mortar branches the way traditional banks do. As the cost of attracting and retaining deposits goes up, banks are more selective about how they then, in turn, lend that money out. A tip from a banker: to have a better chance of a bank approving your loan request, make sure your deposits are held at that bank. Banks like to have the full banking relationship, and every bank wants deposits right now. Plus showing you have deposits in the bank is a sign of strength in the underwriting process and may tip the balance in your favor.
LIQUIDITY
One of the most significant events of 2023, banking or otherwise, was the collapse of Silicon Valley Bank and the subsequent failures of First Republic, Signature Bank, and Credit Suisse. These banks all failed because of a number of different variables including poor management and lax oversight, but an overarching variable was these banks’ lack of liquidity. When customers started withdrawing deposits at a brisk rate, the banks did not have the liquidity to honor them because so many of the deposits they did hold had been invested in long-term, low-yield bonds and notes. In order to meet withdrawal demands, these banks had to start liquidating their investments at a loss, which triggered a cascade of negative outcomes. Most banks today are not facing this same level of risk; risk management teams are generally prudent and banking remains, mostly, a conservative industry especially at the local level. But these bank failures spooked bank leadership teams, boards of directors, and others, and banks have been scrambling to sure up their liquidity positions in recent months. As with the concerns noted above about spreads, banks are simply being more selective about how they lend out money because keeping the dollars held in the bank itself to ensure strong bank liquidity is a worthy a goal in and of itself right now.
What it Means for Borrowers
To begin with, the tightening up of lending standards will simply mean fewer loans will be offered. Borrowers who are used to being approved for loans by their local bank may find the door getting closed on them, at least for the time being.
For loans that are offered, banks are implementing mechanisms to protect themselves, including:
Charging wider spreads on top of already-high interest rates; 63% of those bankers surveyed reported their banks have been more aggressively charging greater premiums for riskier loans.
The use of covenants, which may include things like requiring one year of loan payments to be kept in an escrow account with the bank or that the interest rate on the loan will increase by half a point after one year if the project or borrower does not demonstrate positive cash flow. 37% of bankers noted increased used of such covenants.
Tightening collateral requirements; 27% of bankers report temporary changes to internal guidelines related to collateral. For example, if a bank typically lends up to an 80% loan-to-value ratio on commercial real estate, the bank may now be lending at only 70-75% as a way to guard risk, which would mean that the borrower would have to come up with more of their own funds.
The size of loans is also getting reined in a bit too: 38% of bankers report tighter standards on loan size and 29% report reducing the maximum terms of new loans offered; a loan that may have been offered with a 20-year term last year may only be offered with a 15-year term this year, for example.
As a quick aside, the Senior Loan Officer Survey also asks questions about what bankers are seeing for demand out there: 62-65% of those surveyed reported weaker demand for commercial and industrial loans among small and large businesses, respectively, while 76% said that demand was either moderately or significantly weaker for multiunit rental properties; just 3% of the senior loan officers said that demand for mulitunits is stronger today than it was three months prior.
What it Means for the Economy
On a micro-level, losing access to financing could be very bad news for a business in need of immediate liquidity. An inability to obtain a loan may greatly impact a business’s viability or jeopardize its very existence. That is among the reasons why having a strong relationship with a local banker is so important, especially in times of need or uncertainty, because a good banker will help a borrower through their most challenging periods.
But on a broader level, tighter lending standards will have the effect of slowing down the economy, which is, of course, the Fed’s primary objective in raising interest rates the way they have over the past year as a way to reduce inflation. Less financing means fewer expansions, not as much hiring of new employees, and less frequent mergers and acquisitions. In short, less bank lending activity means less growth. This will have a cooling effect on both inflation and the economy as a whole. The question of whether inflation can fully moderate without the U.S. economy going into a recession remains.
Will standards loosen back up in the months ahead? Probably not. Banks are hunkering down and trying to build or maintain what Jamie Dimon of JP Morgan Chase has referred to as “fortress balance sheets.” Appetite for risk is low, and until there is some clarity on if and when interest rates will come down and how the overall economy will hold up through the rest of the year, lending is likely to continue to be tight.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. © Ben Sprague 2023.
I was off for much of the past week so no Weekly Round-Up this time around. Check back again next Sunday for an extra dose of links and articles. Have a great week, everybody!
