Fed Says Banks Toughen Lending Standards Amid Slump (Update3)

By Craig Torres


Aug. 11 (Bloomberg) -- The Federal Reserve said more banks made it harder to borrow money as defaults and delinquencies on home loans soared and the economy faltered.

Most ``domestic institutions reported having tightened their lending standards and terms on all major loan categories over the previous three months,'' the Fed said today in its quarterly Senior Loan Officer Survey.

Funds were scarcer for homebuyers and small businesses, credit card loans became tougher to get, and even banks' best customers were subject to greater scrutiny. Tighter credit may delay any recovery in economic growth, which economists forecast will slow well into next year.

``The credit crunch is intensifying,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. ``It reinforces the view that the economy will be weak in the next several months and there will be renewed pressure on the Fed to start easing again.''

The survey, conducted last month, covers 52 domestic banks with combined assets of $6.1 trillion, along with 21 foreign institutions. About 75 percent of U.S. banks indicated they tightened standards on prime mortgage loans, up from 60 percent in the previous survey, the central bank said.

Bank stocks pared gains after the report. The Standard & Poor's Financials Index gained 5.49 points to 299.57 in New York. The index climbed as high as 305.23 before the survey was published.

Defying Monetary Policy

The Fed has reduced its main rate 3.25 percentage points over the past 11 months to 2 percent. Still, rates on a 30-year mortgage stood at 6.52 percent Aug. 7, nearly unchanged from 6.59 percent a year ago, according to data from Freddie Mac.

``When the Fed started to cut rates, mortgage rates and other rates were actually lower than they are today,'' former San Francisco Fed Bank President Robert Parry said before the report. ``To say that things are easier in many areas of credit would be mistaken.''

Banks may be reluctant to lend against housing collateral that is falling in value. Home prices in 20 U.S. metropolitan areas dropped 15.8 percent in May, the biggest decline since record keeping began in 2001, according to the S&P Case-Shiller Home-Price Index.

`Bandwagon Effect'

``There is a bandwagon effect,'' said Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. ``When times are tough, the herd starts running in the other direction, with tougher standards pretty much across the board.''

About 30 percent of U.S. banks said they had sold mortgages of as much as $729,750 to Fannie Mae or Freddie Mac during the prior three months, or had the two companies package the loans together as mortgage bonds, the Fed said.

The economy is also faltering. The unemployment rate has moved up 1 percentage point during the past 12 months to 5.7 percent, while delinquencies on home loans to borrowers with weak or limited credit histories rose to 18.8 percent in the first quarter from 13.8 percent a year earlier.

``Large majorities of domestic respondents reported having tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the previous three months,'' the Fed said.

Of the 32 banks that originate non-traditional mortgage loans, about 85 percent reported tighter lending standards, up from 75 percent in the prior survey, the Fed said.

Prime Standards

For prime mortgage loans, about 45 percent of domestic banks said they would tighten standards in the second half of this year, and about 30 percent of domestic banks said they anticipated tightening standards in the first half of 2009.

About 65 percent of domestic banks indicated they had tightened their lending standards on credit card loans over the previous three months, up ``notably'' from about 30 percent in the April survey, the Fed said.

Most banks increased loan rates over their cost of funds for commercial and industrial borrowing, according to the central bank. The proportion of banks raising such rates rose to a net of 80 percent, compared with 70 percent in the April survey.

``Very large majorities of domestic and foreign respondents pointed to a less favorable or more uncertain economic outlook, their banks reduced tolerance for risk and the worsening of industry specific problems as reasons for tightening their lending standards'' on commercial loans the Fed survey said.

Business Credit

Some 55 percent of domestic banks surveyed told the Fed that they would continue tightening credit standards for business loans in the second half of this year, with 65 percent of the institutions making terms stricter for loans to small firms.

Policy makers left the benchmark lending rate unchanged Aug. 5 and said ``financial markets remain under considerable stress.''

Federal funds futures traders see a 69 percent chance that the benchmark lending rate will remain unchanged at the October 29 meeting.

``The case for tightening this year is fading,'' said Brian Sack, vice president at Macroeconomic Advisers LLC in Washington and a former Fed Board economist.