The Federal Reserve releases its first quarter 2012 bank survey which helps gauge today’s lending environment.
Every quarter, the Federal Reserve conducts an extensive survey of lending officers at domestic banks and at the domestic branches of foreign banks operating in the U.S. The results of this survey provide key insight into what decision makers in the lending process are thinking and doing. The survey from the first quarter of 2012 has been released and the news is mixed. Lenders are showing flexibility when it comes to medium and large size businesses but terms and rates remain unchanged for small businesses.
Why Business Loans Are Getting Cheaper
Reduced Rates
According to the survey, Commercial and Industrial loans are becoming less expensive and the terms, like covenants, associated with these loans are loosening somewhat. Nearly 6 out of 10 survey respondents reduced the interest rate charged on business loans. Since many loans have a floating rate, the reduction is through the methodology used for calculating the rate on the loans.
Typically these loans consist of a benchmark rate, like LIBOR, plus an additional interest percentage. The lending officers that reported a reduction in rates are doing so by lowering this additional interest.
Another important metric used to determine the interest rate on business loans is the spread between the bank’s cost of funds and the lending rate. Put simply, the money that banks loan out comes from depositors to whom they pay an interest rate. The rate they pay depositors must be less than the rate they charge to borrowers. The difference between the two is called the Net Interest Margin and it’s one of the principal ways banks make money. Recently, lending officers have indicated that they are reducing their Net Interest Margin by charging less on Commercial and Industrial Loans.
The survey further shows that about one in three lending officers have reduced the use of interest rate floors. A floor modifies the formula described above for variable loans or lines of credit by indicating a minimum interest rate. So if the formula results in an interest rate below the floor rate, the floor rate prevails. By reducing the use of floors, interest paid by borrowers has the potential to fall as overall interest rates in the economy fall.
Driving Change
Previous surveys indicated that banks were either making loans more expensive, more difficult to obtain or both. In this case, loan officers have not fundamentally changed their outlook on the economy nor have borrowers with less risk knocked on their door. According to the survey the aggressive pricing is due to competition from other banks. This certainly makes sense.
