Banks impose severe lending standards

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Banks sharply tightened lending standards in the latest quarter, even for their prime customers — the most vivid evidence yet of a widening credit crunch that started with subprime loans last summer, the Federal Reserve said yesterday.

The much stricter standards imposed by banks — such as requiring higher down payments, more home equity and better credit scores — applied to every loan category: mortgages, home-equity loans, consumer-installment loans, credit cards, commercial real estate and business loans. The increase in mortgage standards in the Fed's January survey was much sharper than that seen in the early 1990s credit crunch.

In another danger sign for the economy, the Fed found a significant weakening of demand for loans across the board. And banks, which face financial difficulties themselves because of bad loans and investments, also said they have raised interest rates and fees they charge on their loans.

The tightening of credit was so pervasive that it likely was an important factor motivating the Fed to slash interest rates by a record amount in the past two weeks. The Fed on Thursday cited "considerable stress" in financial markets as a reason for its latest rate cuts, and said that "credit has tightened further for some businesses and households."

The survey found that homeowners with good credit scores seeking conventional 30-year loans are encountering stricter terms at 55 percent of banks, up from 40 percent last fall, while those seeking "nontraditional" mortgages, including interest-only and payment-option loans, are having to clear higher hurdles at 85 percent of banks.

Only a handful of banks surveyed — seven, according to the Fed — continue to offer subprime mortgages, and five of them have ratcheted up their standards. More than 32 percent of banks also are making it more difficult to get consumer-installment loans, while nearly 10 percent have increased restrictions on credit cards.

The crunch was most dramatic in commercial real estate — a sector of the economy that boomed last year but is among the most vulnerable to tightening credit.

The survey found that a record 80 percent of banks are more-carefully scrutinizing office buildings, apartments and other big construction projects. Nearly half of banks reported that demand for such loans is down.

A separate survey by the Mortgage Bankers Association yesterday revealed a 16 percent drop in commercial real estate loans during the fourth quarter, after a robust 38 percent increase in the first half of the year. Commercial loan securitizations dropped 30 percent in the second half of the year, after surging 70 percent in the first half, the group said.

Large corporations and Main Street businesses also are encountering higher costs and difficulties obtaining loans. A third of domestic banks and two-thirds of foreign banks said they tiightened standards and increased the interest rates they charge on loans.

Banks said they were compelled to deny loans by the shakier economic environment and their own financial problems, which require them to conserve capital and fund only higher-quality loans.

Despite the significant bank pullback documented by the Fed, Alexander P. Paris, an analyst at Barrington Research, said the acute credit crunch seen last fall in the bond and commercial paper markets has eased. Commercial paper or short-term corporate debt offerings increased a modest $66 billion last month, after collapsing by $450 billion from August to late December.

The liquidity crisis banks encountered at the turn of the year also eased, he said, with key interbank lending rates like the London Interbank Offered Rate, or Libor, down by nearly half from its August peak. Since many adjustable-rate mortgages are tied to the Libor rate, that will help homeowners who face resets in coming months, he said.

One ironic result of the market collapse seen last fall is that corporations that needed to borrow applied for bank loans instead of floating bonds — leading to a surge in commercial lending at banks even as they were making their standards more rigid, he said.

"So far in 2008, nearly all categories of bank lending have been strong," despite the tighter standards, Mr. Paris said, contending the Fed's dramatic rate cuts probably were not needed because markets already were on the mend.

David Greenlaw, an economist at Morgan Stanley, said the Fed's dramatic rate cuts provide an important offset to the tighter credit standards. The sharp reduction in rates has set off a big mortgage-refinancing wave, but the credit crunch is limiting it to only half the level seen in 2003, which was the "the mother of all refi booms," he said.