Publications: 2003 Survey of Credit
Underwriting Practices National Credit Committee September 2003
Introduction
The Office of the
Comptroller of the Currency (OCC) conducted its ninth annual survey of credit
underwriting practices during the first quarter of 2003. The survey identified
trends in lending standards and credit risk within the national banking system
for the most common types of commercial and retail credit offered by national
banks.
The 2003 survey included the 66 largest national
banks and covered the 12-month period ending March 31, 2003. Although mergers
and acquisitions have altered the survey population somewhat, the surveys for
the last eight years have covered substantially the same bank group. All
companies in the 2003 survey have assets of $2 billion or greater. The aggregate
loan portfolio of banks included in the 2003 survey was approximately $2.2
trillion as of December 31, 2002. This represents 91 percent of all outstanding
loans in national banks.
The OCC examiners-in-charge of the surveyed banks
were asked a series of questions concerning overall credit trends for 18 types
of commercial and retail credit. Commercial credit for purposes of this survey
included 10 categories of loans: syndicated/national loans, structured finance,
asset-based loans, middle market loans, small business loans, international
credits, agricultural loans, residential construction, commercial construction,
and other commercial real estate. For this year's survey, commercial real estate
was split into three product types-residential construction, commercial
construction, and other, which includes non-construction owner-occupied and
investor property. Retail credit consisted of eight categories of loans:
residential real estate mortgages, affordable housing, credit cards, other
direct consumer loans, indirect consumer paper (loans originated by others, such
as car dealers), consumer leasing, conventional home equity, and high
loan-to-value (HLTV) home equity loans.
The term "underwriting standards," as used in this
report, refers to various requirements, such as collateral, loan maturities,
pricing, and covenants, that banks establish when originating and structuring
loans. Conclusions about "easing" or "tightening" of underwriting standards are
drawn from OCC examiners' observations since the 2002 survey. A conclusion that
the underwriting standards for a particular loan category have eased or
tightened does not indicate that all the standards for that particular category
have been adjusted. It indicates that the adjustments that did occur had the net
effect of easing or tightening such underwriting criteria.
Part 1 of this report discusses the overall results
of the survey. Part II depicts the survey results in graphs and tables.
Part I - Overall
Results
Primary
Findings
- The 2003 survey results for commercial underwriting indicate a slowing
in the pattern of tightening standards that has prevailed since 2001. The
economy and its effect on product performance continue to exert significant
influence over commercial underwriting.
- Retail underwriting standards continue to evidence greater stability.
Most banks reported retail underwriting standards were unchanged, but when
standards were changed, tightening outweighed easing.
- For the first time since 2000, examiners report that credit risk in the
commercial loan portfolios, while still increasing, is starting to moderate.
Portfolio trends for retail credit, similar to prior years, are relatively
constant.
Although the majority of banks reportedly tightened
commercial underwriting standards during the 12 months covered by the 2003
survey, the percentage of banks tightening standards declined. Tightening of
commercial underwriting standards peaked at 67 percent in 2002 and decreased to
60 percent for the current period. Similar to 2002, most of the remaining
surveyed banks reportedly made no changes to commercial standards. Examiners
also reported that six percent of the surveyed banks eased commercial
underwriting standards, compared to no banks easing commercial standards in
2002. Both the decreased rate of tightening and the reappearance of easing,
albeit at a very low level, suggest that the current credit cycle may be ebbing.
The change in commercial underwriting at the product
level is one of degree, with most products evidencing slightly less tightening.
Two products that continue to experience credit quality problems, structured
finance and syndicated/national loans, received the greatest tightening, albeit,
at slightly lower levels than in 2002. Examiners also reported that the level of
tightening increased for three products - agriculture, asset-based, and
international loans - reflecting sectoral problems in agriculture and
international and a wave of restructured loans for troubled borrowers in the
asset-based loan category. Consistent with the 2002 survey, examiners reported
the three primary reasons for tightening commercial underwriting standards were,
in order of importance, economic outlook, risk appetite, and product
performance. The most common methods to tighten standards were adjusting
covenants, collateral, and the amount of the credit line. All three of these
methods provide more structural support to better control the risk in a credit
facility. Pricing, which has been one of the most frequently cited methods used
both to tighten and to ease credit standards in prior surveys, dropped to fourth
place.
Examiners reported a subtle shift in commercial
credit risk trends. At the portfolio level, for the first time since 2001, more
examiners reported no change in credit risk for the past twelve months than
those reporting increased risk. Additionally, for all of the commercial
products, examiners reported smaller increases in credit risk, year-over-year.
Little change is observed from 2002 to 2003 in the
survey results for retail credit. Most of the surveyed banks, 46 percent,
reportedly made no changes to retail underwriting standards in 2003, and
tightening outweighed easing for those banks changing the standards. The primary
reason for tightening was a change in risk appetite, followed by the economic
outlook. The economy had a significant bearing on tightening for both retail and
commercial standards, but its impact was much greater on commercial
underwriting; in this instance, over 75 percent of the banks identified the
economy as a reason for tightening compared to just over 50 percent for retail.
Modifying scorecard cut-offs remained the preferred method of tightening retail
underwriting, followed by adjusting collateral and pricing.
At the retail product level, examiners reported the
majority of surveyed banks did not adjust underwriting standards. While
tightening remained more prevalent than easing, there was an increased level of
easing for several retail products; and two products, credit cards and
conventional home equity loans, exhibited a material degree of easing. The
primary reason for retail easing was competition.
Risk trends for retail credit indicate that the
majority of banks experienced no change in the overall level of risk for the
past twelve months, while a somewhat lower percentage of respondents expect
retail credit risk will remain unchanged for the next 12 months. At the product
level, six of eight retail products were reported to have increased credit risk,
but in most instances, for each of those products, almost as many banks reported
decreased levels of risk. Home equity products exhibited the greatest increase
in risk, followed by credit cards and indirect consumer loans. Although credit
cards and home equity products are significant portfolios for several banks,
retail portfolios are dominated by residential mortgages, which historically
have exhibited stable, low-risk profiles.
Commentary
In this ninth year of the OCC
underwriting survey, we begin to have a sense of a full credit cycle. In 1995,
the first year of the survey, we reported banks were relaxing their underwriting
standards in response to competitive pressures. Commercial underwriting
standards experienced a significant wave of easing over the next few years and
then, beginning in 1999, a period of tightening that only recently has started
to ebb. Throughout this period, retail credit exhibited greater stability with
selective easing and tightening of certain products. Also, during this period,
credit risk was building in commercial and retail portfolios as a result, first,
of liberalized underwriting, and, second, a weakening economy. Banks experienced
deteriorated performance in segments of both portfolios, but better risk
management and diversified sources of income helped to contain problems at
manageable levels. Now, there are indications that credit risk is beginning to
abate as the economy show signs of recovery.
As we look back on this cycle and the trends in
underwriting and credit risk, certain themes emerge:
· Decisions about
risk selection and underwriting practices need to be made in tandem. Targeting
a higher-risk customer or market segment without a corresponding adjustment to
underwriting standards often introduces higher-than-intended levels of risk.
· Competition
pressures banks to move away from prudential underwriting standards. Banks
need to redouble diligence during periods of intense
competition.
· Basic credit
principles - sound underwriting, unbiased risk identification, active
portfolio management, robust management information systems, and good controls
- need to be sustained throughout the credit cycle.
With these themes in mind, two portfolios are
noteworthy. Home equity lending has experienced tremendous growth for the last
three years, and many banks plan to continue to increase this product over the
next 12 months. In addition, the underwriting for home equity products has been
subjected to a fair degree of easing during the last several years. The degree
of easing is particularly significant when the proliferation of
high-loan-to-value home equity loan products is considered. While the
performance of home equity loans remains strong, banks need to be alert to the
risks that are introduced when high growth is coupled with liberalized
underwriting.
The second portfolio of note is commercial real
estate. This is a significant product line for many banks and another portfolio
with liberalized underwriting standards and high growth rates, particularly in
regional and community banks. Certain metropolitan markets and property types
such as offices, hotels, and multifamily housing are experiencing high vacancy
rates. In the 2003 survey, examiners reported that commercial real estate is the
product posing the greatest potential risk to their companies. To date,
performance has been satisfactory, but market conditions, underwriting trends,
and unseasoned portfolios raise concern about the embedded risk in these
portfolios. Also, when interest rates start to move up, commercial real estate
portfolios may be exposed to added stress.
The OCC will continue to focus supervisory attention
and resources to ensure that credit risk in national banks is accurately
classified and that credit risk management practices are commensurate with risk
levels.
Part II - Graphs
Part II - Tables
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