Banks Adopt Tighter Terms for Lending, Survey Says

By SUDEEP REDDY, MARSHALL ECKBLAD and DAN FITZPATRICK Most U.S. banks tightened lending to consumers and businesses in recent months, an ominous sign for an economic recovery pegged to easing the flow of credit to borrowers. In a survey of banks released Monday, the Federal Reserve said about two-thirds of banks' loan officers reported that they tightened terms for business loans over the past three months. While that was better than the 85% reporting in October that they had tightened terms -- such as the cost of credit or collateral requirements -- over the prior quarter, the survey still shows how strict lending standards instituted in the wake of last fall's credit freeze continue to block potential borrowers from accessing credit. The sentiment also underscores troubles with the government's Troubled Asset Relief Program, or TARP, which doled out more than $200 billion to troubled financial institutions with the goal of lending out fresh capital and jump-starting the economy. Businesses said that has hardly been the reality. "I find it ironic" that TARP money was supposed to ease credit, said 51-year-old Christian book publisher Jeffrey Campbell, owner of the two-person Tau Publishing in Phoenix. "It is only tightening it up. I don't think it is working the way it is supposed to be working." Mr. Campbell said he and his wife have credit scores well above 700, own two homes that are worth more than what they owe and pay their credit cards "as soon as we get the bill." Yet his business credit cards have seen their limits slashed -- his Bank of America Corp. card was nearly halved from $15,000 to $8,800, while another line of credit from another provider was eliminated altogether -- even as rates have gone up. With less credit, Mr. Campbell said he won't be able to purchase additional book-binding equipment and will have to seek outside vendors to do the job, thereby raising his expenses. "There is really something wrong with this picture," he said. Bank of America declined to comment on Mr. Campbell's situation, but spokesman Scott Silvestri noted that in the fourth quarter the company's small-business banking unit extended nearly $1 billion in new credit to more than 47,000 new customers, and the bank made more than $115 billion in new loans across all categories. The Fed, in its quarterly senior-loan-officer survey, said banks "pointed to a less favorable or more uncertain economic outlook as a reason for tightening their lending standards and terms" on business loans. Most loan officers also cited worsening industry-specific problems and their banks' reduced tolerance for risk. For their part, banks point to a drop-off in demand for the pullback in lending. They also said they haven't had enough time to make new loans. According to the Fed survey, about two-thirds of banks said demand for business loans had actually weakened in the prior three months, with less than 10% reporting that demand had risen. Most banks that reported a drop in demand said customers cut investment in equipment and plants. Deepening trouble throughout the financial system and the economy has spurred banks to become more cautious about lending practices, directing loans to the most creditworthy customers. The tightening policies are weighing on economic activity and threatening to worsen the recession, which is entering its 15th month. The government has rolled out numerous programs to grease credit flows to businesses and consumers. The first half of the $700 billion financial-sector rescue to the banking system was intended to spur more lending from financial institutions. But with banks proving slow to ramp up lending, lawmakers now want to place requirements on firms that receive taxpayer funds. The latest government effort, by the Treasury Department and Fed, is expected this month to promote consumer lending in a market from which many investors who buy packaged loans have fled. Loan demand from consumers didn't fall as rapidly as it did for businesses, or as much as it had in the prior survey. About 40% of banks said demand for prime mortgages -- for customers with the best credit -- became weaker during the survey period into mid-January, while almost a third said demand became stronger. That is probably the result of falling mortgage rates after the Fed announced plans in November to buy mortgage-related assets. Still, almost half of all banks said they tightened credit standards on prime mortgages. Almost 60% tightened standards on consumer loans such as credit cards. Almost half reported tightening terms and conditions for existing consumer credit-card accounts, and roughly the same share reported raising the minimum required credit score. About 40% said they raised interest rates over their cost of funds for individuals' credit cards. For business loans, about 90% of banks said they increased the spread, or interest rate, on loans over the cost of funds. Banks are pulling back, in part, to respond to earlier loosening of loan terms. Bank of America, for instance, pushed further into small-business lending by reducing its underwriting standards in order to write more loans. Until August of 2006, the company lent money only to businesses that had existed for at least two years. But just more than two years ago, the firm started offering unsecured credit lines of up to $100,000 to start-ups. From October through December of last year, Bank of America said it took permanent losses on about 2.9% of its outstanding small-business loans, an annual loss rate of almost 12%. As of one year ago, the Charlotte, N.C., bank's permanent loss rate on small-business loans was about half its current level, or about 6%. Small-business owners who still can get credit said the standards are getting tougher. "They're making us jump through a few more hoops," said Patrick Ryan, co-owner of Ryan Brothers Ambulance Service, of Madison, Wis. Mr. Ryan said his longtime lender asked for more information than normal on his last visit: "Our banker just said...'We normally don't do all this research,'" but that the bank was performing more due diligence even for the banks longstanding customers. Write to Sudeep Reddy at sudeep.reddy@wsj.com, Marshall Eckblad at marshall.eckblad@dowjones.com and Dan Fitzpatrick at dan.fitzpatrick@wsj.com