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. Leveraged Loans 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.
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.
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