Publications: 2004 Survey of Credit
Underwriting Practices National Credit Committee September 2004
Introduction
The Office of the Comptroller of the Currency (OCC) conducted its tenth annual survey of credit underwriting practices during the first quarter of 2004. The survey identified trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks.
The 2004 survey included the 72 largest national banks and covered the
12-month period ending March 31, 2004. Although mergers and acquisitions have
altered the survey population somewhat, the surveys for the last nine years have
covered substantially the same group of banks. All companies in the 2004 survey
have assets of $2 billion or greater. The aggregate loan portfolio of banks
included in the 2004 survey was approximately $2.3 trillion as of December 31,
2003. 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 (leveraged finance),
asset-based loans, middle market loans, small business loans, international
credits, agricultural loans, residential construction, commercial construction,
and other commercial real estate. 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
requirements, such as ones related to 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 2003 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 2004 survey results for commercial credit
underwriting indicate increased easing, and a significant decrease in
tightening of standards. Stepped-up competition and a more optimistic
economic outlook are the primary drivers for the easing.
- Underwriting standards for retail credit products also reflected more easing and less tightening, but the change from prior years was less pronounced.
- Examiners are more positive in their assessment of the credit risk environment for both commercial and retail credit portfolios. On net, they report that credit risk has declined during the past year, and they expect it to remain at lower levels during the next year.
Commercial Underwriting Standards
In 2004, slightly more banks eased credit underwriting standards than tightened them. Examiners reported that 13 percent of
banks eased, 12 percent tightened, and 75 percent did not change their commercial underwriting standards.
In 2003, by contrast, many more banks tightened than eased: examiners reported that 47 percent of the banks tightened and
only 5 percent eased standards. In 2002, no banks were reported to have eased commercial underwriting standards,
two-thirds tightened, and one-third made no change. In summary, banks have shifted toward easing over the past few years.
In 2002, the net change in standards favored tightening by 62 percent. In 2003, the net difference in favor of tightening
slackened to 42 percent. By 2004, net change favored easing by 1 percent.
Commercial underwriting trends at the product level confirm this shift toward easing. The two commercial products that
experienced the greatest amount of tightening during the last four years - structured finance and syndicated/national
loans - are the front-runners in the swing toward easing. Structured finance provides the most conspicuous example of
this shift. In 2004, examiners reported that 15 percent of the banks eased and no bank tightened underwriting for
structured finance, compared with no easing and 96 percent tightening four years ago. Examiners also reported a return
to net easing for middle market and asset-based loans. While tightening was slightly more prevalent than easing for the
remaining commercial products, the percent of banks reported to have tightened in 2004 was much lower than in 2003.
Large banks made more adjustments in underwriting standards than smaller banks, and most of their adjustments eased standards.
Examiners cited stronger competition as the primary reason why banks eased commercial standards, followed by an
improving economic outlook and risk appetite. When easing standards, banks commonly lowered pricing, lengthened maturity,
increased the amount of the credit line, and adjusted covenants. For banks that tightened commercial underwriting standards,
the primary reasons cited were risk appetite and the economic outlook. When tightening standards, banks commonly adjusted
covenants, lowered the amount of the credit line, and increased collateral requirements.
Examiners reported that credit risk trends in commercial portfolios have moderated. They reported that the percentage of
banks with decreased commercial credit risk slightly exceeded those banks with increased risk. While the difference between
increased and decreased risk is small, the shift is significant - this is the first time that survey results indicate that more
banks experienced a net decrease of credit risk in the commercial portfolio. The shift in risk is attributed to improvements
in portfolio quality, external conditions, and portfolio management practices. Structured finance and syndicated/national loans
were perceived to have the greatest decrease in risk. Examiners also reported that banks expect credit risk to decline during
the next 12 months.
Retail Underwriting Standards
Retail credit tends to be less volatile than commercial credit and, accordingly, retail underwriting standards tend to be
more stable. For retail portfolios, although the number of banks easing (13 percent), tightening (13 percent), or making no
change (74 percent) is remarkably similar to that reported for commercial credit, the change from tightening to easing has been
far more gradual. At the product level, there was only a modest change in underwriting standards from the prior year. For most
products, tightening exceeded easing, but the amount of tightening has moderated. Examiners reported that easing outweighed
tightening for home equity products; credit cards also experienced easing.
According to examiners, banks eased retail standards primarily because of increased competition and changes in market
strategy. When easing, banks reduced debt service requirements, extended amortization schedules and lowered collateral
requirements. Sixty-five percent of banks cited risk appetite as the primary reason for tightening, followed by product
performance and a change in market strategy. Banks adjusted score-card cutoffs and increased debt service requirements to
tighten underwriting standards.
Examiners reported that 75 percent of the banks surveyed reported no change in the overall level of retail credit risk for
the past 12 months, and 69 percent of banks expect retail credit risk will remain stable for the next 12 months. At the product
level, only three of eight retail products were reported to have a net increase in credit risk in the past 12 months - credit
cards and the two home equity products. Examiners cited a decline in the quality of credit card portfolios and concern about
external conditions for credit cards and the two home equity loan products as the reasons for the increased risk.
Commentary
With our tenth survey of credit underwriting practices, we have come a full cycle. In 1995,
the first year of the survey, we reported banks were relaxing underwriting standards because of increasing competition.
Now, ten years later, banks again are relaxing their underwriting standards - and for the same reason.
Much has changed in ten years, and banks are in a better position to evaluate and manage the risk associated with easing
underwriting standards. Advancements in credit risk management have given banks better tools to differentiate risk and
understand the implications of underwriting changes. Additionally, the condition of the banking industry is sound with strong
capitalization and record profits. A favorable interest rate environment and an economy that is gradually gaining strength
also contribute to the positive credit outlook.
At this phase in the credit cycle, some adjustments to underwriting criteria are to be expected. After several years of
sluggish demand for commercial loans, banks are anxious to make deals. However, ambitious growth goals in a highly competitive
market can create an environment that fosters imprudent credit decisions. It is now that banks need to be disciplined and adhere
to the enhanced credit risk management practices they implemented during the past few years. Exceptions to underwriting
standards need to be carefully controlled and monitored and relationship managers must be held accountable for both the
quality and the quantity of their deals.
Although many factors contributed to the weakness in commercial credit portfolios during the last cycle, certainly excessive
leverage was one of the primary causes. Many observers have commented on how quickly creditors' tolerance for higher leverage
has rebounded. Bankers are urged to maintain prudent limits on leverage in their underwriting criteria and should refer to OCC
Bulletin 2001-18, "Leveraged Finance - Sound Risk Management Practices," for guidance.
While demand for commercial credit has been lackluster, demand for retail credit has been robust. Many banks have grown
their retail portfolios in recent years, largely because of strong consumer demand for residential mortgages and home
equity products. Low interest rates, appreciation in home values, and innovative products have sparked the demand.
Because of the wave of refinancings, many banks have relatively unseasoned mortgage and home equity portfolios.
Additionally, the growing component of adjustable-rate mortgages and the protracted interest-only period associated
with many home equity lines of credit mean that many borrowers could be exposed to much higher payments when interest
rates rise and principal amortization begins. Banks are encouraged to make sure that risk management practices keep
pace with the changing risk characteristics of their retail portfolios brought about by changes in underwriting practices.
The OCC will continue to focus supervisory attention and resources to ensure that credit risk in national banks is
appropriately identified and that credit risk management practices are commensurate with risk levels.
Part II - Graphs
Part II - Tables
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