Five Things You Need to Know: A Closer Look at Credit Demand

Every quarter dating back to 1966 the Federal Reserve publishes its Senior Loan Officer Opinion Survey where, as the name implies, senior loan officers at banks around the country are asked about lending conditions in U.S. credit markets.  The banks included may vary slightly from quarter to quarter. Included in the most recent current report are responses from 55 domestic banks and 22 U.S. branches of foreign banks.

Senior loan officers are on the front lines of the Federal Reserve's war against credit contraction.  They are not so much pawns in the battle as majors leading the charge.  Not only do these majors observe first hand the demand for credit among businesses and households, they also are many times involved directly in decision-making that impacts credit availability to both businesses and households. 

Now, let's get a bit of context. In February 2008 we got our first look at the front lines of credit demand for the fourth quarter of 2007 leading up to the Bear Stearns and Lehman Brothers collapses in 2008. The excerpt below is my take on the report from Five Things You Need to Know: Everybody, Back Into the Woods! Back Into the Woods!:
 

"The net of the survey is a clear pattern of a combined tightening of credit standards and weakening loan demand spread across a wide range of loan types. If there was a lingering perception that credit issues are contained to real estate, specifically subprime, then this report should end any doubts.

About 55 percent of domestic respondents indicated that they had tightened their lending standards on prime mortgages, up from about 40 percent in the October survey.

Concerning residential real estate loans, between about 70 percent and 80 percent of domestic respondents expect the quality of their prime, nontraditional, and subprime residential mortgage loans, as well as of their revolving home equity loans, to deteriorate in 2008.

The bottom line is that credit issues are widespread and infecting both business and household loan demand as well as lending standards."

Fast forward to August, 2008, as we head directly into the eye of the Bear and Lehman storm. From Minyanville: Five Things You Need to Know: Song of the Goat, an analysis of the second quarter 2008 SLO:
 

"So this is where things stand. Fannie Mae said last week it will no longer buy and guarantee Alt-A mortgages because the default rates on these mortgages are increasing at a rapid rate. The number of Alt-A loans where payments are 60 days late has quadrupled from a year ago to nearly 13%, according to the First American CoreLogic. Even worse, many Alt-A borrowers are facing upcoming resets that could nearly double their payments.

This is creating new headwinds for housing, even as some have been optimistically predicting stabilizations. Fannie and Freddie are no longer able, and willing, to step up and buy and guarantee entire segments of the housing market. Meanwhile, lenders, according to the Federal Reserve's Quarterly Senior Loan Officer survey are dramatically tightening residential mortgage lending standards, and the reclassification of borrowers based on these tighter standards is showing up in demand."

In October 2008 it was useful to compare the absolute collapse of both credit availability and demand in the context of 2003, from Minyanville: Five Things You Don't Want To Know:
 

By virtually any measure, throughout 2003 the Fed's interest rate policy was successfully resulting in real economic credit expansion. According to the Fed's Senior Loan Officer Survey in April, 2003, "Only 6 percent of domestic banks reported that they had tightened standards on residential mortgage loans in the April survey, down from about 10 percent in both the January and the October surveys."

Meanwhile, as we are all painfully aware, the most recent Senior Loan Officer Survey from July 2008, "Large majorities of domestic respondents reported having tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the previous three months. About 75 percent of domestic respondents—up from about 60 percent in the previous survey—indicated that they had tightened their lending standards on prime mortgages.2 Of the 32 respondents that originated nontraditional residential mortgage loans, about 85 percent—up from about 75 percent in the April survey—reported having tightened their lending standards on such loans.3 Finally, 6 of the 7 respondents that originated subprime mortgage loans—a somewhat higher proportion than in the April survey—indicated that they had tightened their lending standards on those loans over the past three months."

As we progressed through the crisis, we began to see how it's not simply the supply of credit that is important, it is the demand for credit that is key to recovery. So the first quarter 2009 SLO was important to get a sense of what was happening on the front lines of credit. From Minyanville: Five Things: A Silver Lining for the Economy? Or simply a move from horrific to astonishingly awful?:
 

"Although credit conditions remain strained, an April survey of loan officers by the Federal Reserve found a smaller number of banks were tightening loan standards compared with a few months ago."
Wall Street Journal, May 5, 2009, "Fewer Banks Are Tightening Their Lending Standards"

Finally, a little light at the end of the tunnel, right? According to the Federal Reserve's April survey of loan officers fewer banks are tightening lending standards. While that sounds good on the surface, a cursory look at the actual report reveals that the percentage of banks tightening lending standards is still huge, just not as huge as the astonishingly huge percentage reporting tighter lending standards in the prior two quarters. We're now back to the merely horrific levels of 2001 and 2002. Meanwhile, demand for commercial and industrial loans remains weak... Demand for commercial real estate loans continues to collapse... And standards for residential mortgage loans are still tightening.

Fast forward to January, 2011. This was really the first time banks began to report seeing demand for Commercial & Industrial loans increase, a positive. Even so, the demand for residential real estate loans remained severely depressed. See the article Minyanville: Here Are the 6 Charts You Need to See In the Federal Reserve Senior Loan Officer Survey. Now, let's go to the most recent report.


2. Businesses Increasing Demand for Credit

While the fourth quarter 2010 report showed an increase in demand for credit from medium and large businesses, demand on the small business front remained subdued. An important observation made in this report by Bloomberg economist Joseph Brusuelas is that this is the first time since the second quarter of 2006 that both groups, small businesses and medium and large businesses showed increased appetites for credit/.



But that's not all. Bank SLOs also reported seeing increased demand for Commercial Real Estate Loans, most likely from CRE firms engaged in multi-family construction dwellings. I outlined how the absence of demand for single-family residential real estate was translating into a boom for apartment buildings here (See Minyanville: Five Things You Need to Know: Are Recessions Good for Freedom?). Among the multi-family REITs mentioned positively in that piece were Equity Residential (EQR), Avalon Bay (AVB), UDR Inc. (UDR), Colonial Properties Trust (CLP), and Associated Estates Realty Corp. (AEC).




3. Consumer Loan Demand Also Increasing

But of course the fly in the ointment remains the consumer. On the one hand, the availability of installment loans is increasing, with 28.8 percent of banks increasing availability of credit in this space, the highest percentage reading since 1994. Nearly 20 percent of banks reported easing lending standards for credit cards and almost as many reported easing lending standards for auto loans. Still, while demand for auto loans increased the demand for credit cards remained essentially unchanged from the last report.

The primary issue remains demand for residential real estate loans on the consumer side.  While no banks reported tightening standards for residential real estate loans, the demand for residential mortgage loans continues to contract after the brief rebound due to a number of Federal lending programs.

Even worse, take a look at some of the special questions on the SLO Survey:  Apart from normal seasonal variation, how has demand for mortgages to purchase homes changed over the past three months? 45.3 percent of banks surveyed reported demand for prime residential mortgages was moderately weaker. 42.9 percent reported demand for nontraditional residential mortgages was moderately weaker.

Of course, for market and investing applications this is all well and good but it has little to do with the stock market. In fact, it should be made clear that residential real estate will be the very last economic variable to improve. The very last. The dichotomy between the market and economy is quite similar to the dichotomy in business loan demand and residential mortgage loan demand. 
  

4. Time and Our Evolving Perceptions

Yesterday someone forwarded me the following first line from a Washington Post article:  "A day before the attacks of Sept. 11, 2001, it was still possible to believe in the future, like a religion of infinite promise."

Well, that's interesting. As a financial market participant at that time, I can assure you that my perception of conditions the day before 9-11 were far, far different. Perhaps you felt the same as me? The two charts below, both concluding on Sep. `10,2001 illustrate what I mean. The first is the S&P 500.

 

As you can see, in the 25 trading days leading up to Sep. 11, the S&P 500 was down 10.5 percent and had gone down big in eight of the prior 10 sessions. None of us participating in markets at the time felt particularly hopeful.

And then here is the VIX volatility index. Fear was increasing, with the VIX rocketing higher in nine of the prior 10 sessions.

 


5. Beware the Filter Bubble

See what this column, blog, whatever you want to call it, you are right now reading does? It curates things I think are important. It's a filter. From the video description below: "As web companies strive to tailor their services (including news and search results) to our personal tastes, there's a dangerous unintended consequence: We get trapped in a "filter bubble" and don't get exposed to information that could challenge or broaden our worldview." It's a fascinating look at algorithmic content filters and their unintended threat by Eli Pariser, author of "The Filter Bubble."