Banks report tighter lending standards, weaker demand for mortgages and HELOCs

Many U.S. banks have tightened their lending standards for residential real estate (REE) loans and home equity lines of credit (HELOC) in the second quarter amid the collapse of regional banks and a cascade of interest rate hikes by the Federal Reserve to tame inflation.

Banks expect to further tighten standards for the remainder of the year, according to the Fed’s quarterly senior loan officer opinion survey (SLOOS) released on Monday. 

The survey showed that a 20%-plus net share of banks reported having tightened standards on non-qualified-mortgage (QM) jumbo residential loans (21.6%), QM jumbo loans (21.4%) and HELOCs (25%).

A moderate net share of banks tightened standards on non-QM non-jumbo (18.3%), subprime (16.7%), and QM non-jumbo, non-government-sponsored enterprise (non-GSE) eligible loans (12.5%). 

In contrast, only modest net shares of banks reported tightening standards on GSE-eligible (5.4%) and government loans (7.5%). 

When banks become less willing to offer credit, it can have the same effect as the central bank raising rates. Households and businesses find it more difficult and costly to borrow, which tends to limit demand for goods and services.

“You’ve got lending conditions tight and getting a little tighter, you’ve got weak demand, and (…) it gives a picture of a pretty tight credit conditions in the economy,” Fed chair Jerome Powell said last week when asked about the survey results.

The survey showed that a net 33.3% of banks reported weaker demand for HELOCs.

A 40%-plus net share of all U.S. banks said they saw weaker demand for all types of RRE loans except for subprime mortgage loans, which saw a moderate net share (36%) of banks reporting weaker demand. 

The seven categories of residential home-purchase loans that banks are asked to consider are GSE eligible, government, QM non-jumbo non-GSE-eligible, QM jumbo, non-QM jumbo, non-QM non-jumbo, and subprime mortgage loans. 

As for their expectations for the reminder of 2023, respondents gave a fairly gloomy outlook.

“Banks reported expecting to further tighten standards on all loan categories,” the report said. 

“Banks most frequently cited a less favorable or more uncertain economic outlook and expected deterioration in collateral values and the credit quality of loans as reasons for expecting to tighten lending standards further over the remainder of 2023.”

Responses were received from 66 domestic banks and 19 U.S. branches and agencies of foreign banks. Respondent banks received the survey on June 15, 2023, and responses were due by June 30, 2023. The survey asks officers about topics such as changes in lending terms as well as household demand for loans.

The July SLOOS doesn’t point to a surge of credit tightening which some Fed policymakers worried would occur after the failures of three regional banks — Silicon Valley Bank, First Republic and Signature Bank.

Most recently, Heartland Tri-State Bank of Elkhart, Kansas failed on Friday with the Federal Deposit Insurance Corporation (FDIC) taking control — the first bank to fall since First Republic, the country’s second-largest bank failure in early May.

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