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Publications by Type: Survey of Credit Underwriting Practices
The Office of the Comptroller of the Currency (OCC) conducted its 14th annual underwriting survey to identify trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks. The survey covered the 12-month period ending March 31, 2008.
The 2008 survey included examiner assessments of credit underwriting standards at the 62 largest national banks. (The OCC increased the asset threshold for banks in this year's survey from $2 billion to $3 billion.) This population covers loans totaling $3.7 trillion as of December 2007, approximately 83 percent of total loans in the national banking system. Large banks referenced in the subsequent comments are the 20 largest banks by asset size supervised by the OCC's Large Bank Supervision department; the other 42 banks are supervised by the OCC's Midsize/Community Bank Supervision department.
OCC examiners assigned to each bank assessed overall credit trends for 20 commercial and retail credit products. For purposes of this survey, commercial credit includes the following 13 categories:
The term "underwriting standards," as used in this report, refers to the terms and conditions under which banks extend or renew credit, such as financial and collateral requirements, repayment programs, maturities, pricing, and covenants. Conclusions about "easing" or "tightening" represent OCC examiners' observations during the survey period. A conclusion that the underwriting standards for a particular loan category have eased or tightened does not necessarily indicate that all the standards for that particular category have been adjusted. Rather, it suggests that the adjustments that did occur had the net effect of easing or tightening the aggregate conditions under which banks extended credit.
Part I of this report summarizes the overall results of the survey. Part II depicts the survey results in graphs and tables.
Part I: Overall Results
Commentary on Credit Risk
After several years of increasingly accommodative credit terms, the financial market disruption in 2007 caused an abrupt change in risk appetite and a renewed focus on fundamental credit principles by bank lenders. Banks and other investors have suffered major losses resulting from the disruption in their ability to distribute both commercial and retail credit exposures during the past year. The subsequent tightening of credit underwriting standards — higher credit spreads, more financial covenants, less borrower leverage — is the expected response to the mark-to-market losses on the held for sale portfolio as well as investors' more thorough assessment of credit risk. Notwithstanding the recent overall tightening of standards, examiners anticipate that the relaxed underwriting standards of the past, coupled with current economic weaknesses, will result in increased credit risk and losses over the next 12 months. The OCC expects that the lessons learned from the recent market turbulence will lead to more prudent underwriting standards for both commercial and retail credit exposures. The OCC emphasizes that it is important for bankers to maintain and enforce prudent credit underwriting standards throughout the economic cycle, both when financial market liquidity is robust and when it is poor. While the competitive environment will inevitably cause changes in credit underwriting standards, banks need to have risk management and control processes to signal when standards veer away from safe and sound banking practices. Banks should underwrite credit based upon an expectation that the borrower can repay the loan, regardless of whether the loan is intended for portfolio or for distribution. As recent events have clearly shown, liquidity conditions in credit markets can change abruptly. Banks originating credit for distribution should maintain underwriting standards reasonably consistent with the standards for their own portfolio holdings.
Commercial Underwriting Standard
After four years of eased underwriting standards, examiners reported net tightening of commercial credit standards for the 12 months ending March 31, 2008. The 2008 survey results indicate that more than half of the surveyed banks tightened commercial underwriting standards, more than triple the number of banks reported to have tightened in 2007. Only 6 percent of the surveyed banks eased commercial standards, down significantly from 2007. The table below summarizes the changes.
Examiners overwhelmingly cited growing concerns about the economy as the leading reason for more stringent standards. While the economic outlook was a main concern for all commercial products, it was particularly pronounced for commercial real estate (CRE) products. For larger institutions, the disruption in financial markets during the second half of 2007 had a significant impact on the leveraged finance and syndicated loan markets. Examiners cited market liquidity most frequently as the reason banks tightened standards for large corporate and leveraged loans, as well as international and hedge fund exposures.
Credit spreads, or the compensation for assuming credit risk, have risen sharply. Banks have emphasized maintenance financial covenants and lower borrower leverage, as well as increased guarantor support requirements.
Selected Product Trends
Underwriting standards tightened for all commercial loan products surveyed, with over 60 percent of the banks strengthening in at least one product line. The most prevalent tightening occurred in CRE loans, leveraged loans, and counterparty credit exposure to hedge funds. Examiners reported a few isolated instances of eased commercial credit underwriting standards.
Commercial Real Estate
CRE products include commercial construction, residential construction, and other CRE loans. These products are offered by virtually all of the surveyed banks. Net tightening, which measures the difference between the percentage of banks tightening and those easing, was greatest in residential construction, followed by commercial construction. The following tables provide the breakdown by each real estate type.
Examiners most often cited the following as reasons for strengthening of CRE underwriting standards:
CRE remains a primary concern among examiners given the rapid growth of these exposures and banks' significant concentrations relative to their capital. These concerns are compounded by elevated concerns over market conditions in select areas.
Underwriting standards for leveraged loans at the 15 banks in the survey that offered such loans changed significantly in 2007. The easing examiners had noted in the 2006 and 2007 surveys continued until the sharp disruption in financial markets that began last summer. Since that time, most banks have responded to investor concerns and the negative economic outlook by tightening underwriting terms, particularly those relating to pricing, covenants and maximum allowable leverage. However, because banks committed to a number of transactions prior to the market turbulence, there are instances where banks continue to negotiate transactions where underwriting standards are weak. Given that the volume of new transactions has declined significantly since last summer, it is not clear whether the changes in underwriting standards are a temporary reaction to troubled market conditions or a longer term return to more prudent fundamental credit risk principles.
Counterparty Credit Risk
A third product for which banks have tightened credit terms is counterparty credit exposure to hedge funds. While few banks have such exposures (seven banks out of 62), those that do are systemically important institutions and the terms of credit for these counterparties can influence overall liquidity in financial markets. Banks strengthened underwriting standards by raising initial margin requirements and imposing stronger collateral requirements in response to decreased market liquidity, poor overall market conditions, a slowing economy, a decreased risk appetite, and changes in their own financial condition.
Originate to Hold versus Originate to Sell
The OCC added new questions to the 2008 survey to assess any differences in underwriting between loans originated to hold in the bank's own loan portfolio and loans originated to sell in the marketplace. Of the 62 banks surveyed, 27 percent originate loans both to hold and to sell. The products that these banks originate for dual purposes represent only 19 percent of the total product responses. Examiners indicate that the majority of the loans originated in the various product lines are generally underwritten with the same standards. When standards differed, banks have typically mitigated risks of loss by enforcing conservative limits on exposures held.
The most notable difference in underwriting standards is for leveraged loans. Typically, leveraged loans underwritten with the intention to sell had weaker terms than loans originated to hold for investment. Examiners noted significant differences in loan covenants, maturities, amortization periods and fees. The tightening of underwriting standards for leveraged loans originated to sell was the direct result of changes in the economic outlook and market liquidity.
Retail Underwriting Standard
Examiners noted tightening of retail underwriting standards in 68 percent of the surveyed banks citing economic factors as the major basis for the change. No examiners reported overall easing of retail underwriting standards, although some easing was noted in specific products. This is a major change from the past three surveys when examiners reported overall easing at 20 percent or more of the surveyed banks and overall tightening at 13 percent or less.
Examiners reported increased retail credit risk in at least one product at 76 percent of the surveyed banks. This increased level of risk was most pronounced in credit card and home equity lending. Examiners cited concerns about the continued downturn in residential property values and general economic conditions as the bases for increased risk levels. Examiners expect retail credit risk to continue to increase over the next 12 months at 88 percent of the banks, particularly in home equity and credit card portfolios.
Selected Product Trends
In this year's survey, examiners reported tightening of credit standards in a significant number of the surveyed retail loan products. In fact, the responses indicated tightened standards for 46 percent of retail loan products, and no change in the standards for 48 percent. Examiners noted easing of standards for only 6 percent of retail loan products.
As shown in the tables below, tighter underwriting standards were most prevalent in residential real estate and home equity lending products. No banks eased standards for residential real estate loans, and only one bank eased standards for home equity lending (both conventional and high LTV). That bank has since tightened its requirements. Examiners stated that underwriting standards for residential lending-related products tightened mainly because of the dramatic changes in economic conditions.
Where examiners noted tightening, more stringent collateral requirements were cited most frequently, closely followed by scorecard changes and documentation requirements. This conclusion was influenced by the responses on real estate-related lending products, which are the most prevalent products offered by the surveyed banks.
Easing was centered in indirect consumer lending products, for which examiners noted loosening in five of the 25 banks reporting. Relaxed standards typically involved lengthened terms and higher advance rates.
Originate to Hold versus Originate to Sell
National banks originate most retail credit products to hold. At the product level, 69 percent of products were originated exclusively to hold. Another 28 percent of the products were originated both to hold and to sell. Only 3 percent were originated exclusively to sell. Products held and sold, and sold only, were primarily residential mortgages and affordable housing loans. Surveyed banks typically originated residential mortgage and home equity loans primarily from retail branches. Broker and correspondent channels, combined, accounted for 16 percent of residential mortgage originations and 8 percent of home equity loans.
In most banks that originated both to hold and to sell, the underwriting standards for the two groups of originations did not differ. In banks whose underwriting standards for the two groups did differ, the primary differences were in pricing and fees.
Part II: Graphs and Tables