Capital Markets

About Time: Banks Tougher on Borrowers

Comptroller of the Currency survey finds tightening of standards after four loose years.
Stephen TaubJune 12, 2008

Commercial and retail underwriting standards finally tightened after four consecutive years of easing, according a survey from the Office of the Comptroller of the Currency.

Besides the overall economic outlook, it listed the main reasons for the tougher standards as the downturn in residential real estate, a changing risk appetite, and the decrease in market liquidity. Examiners reported that risk in both commercial and retail portfolios had increased over the past 12 months, and they expect portfolio risk to continue to increase over the coming year.

Again, besides the weakening economy, key factors contributing to the rise in product and portfolio credit risk have been rising energy costs, turbulence in the secondary credit markets, the housing market downturn, and the anticipated impact of relaxed underwriting standards over the past few years on payment performance, according to the new survey.

The 2008 survey included the 62 largest national banks, and covered the 12-month period ending March 31. The aggregate total of loans was $3.7 trillion, representing more than 83 percent of all outstanding 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.

Of course, it is not too surprising that banks have tightened their lending standards, given their own financial difficulties stemming from the mortgage crisis and the overall credit dislocations in the global market. “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 report states optimistically. “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.”

According to the report, examiners reported net tightening of commercial credit standards for the 12 months ending March 31, after four years of eased underwriting standards. The results indicate that more than half 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.

“Examiners overwhelmingly cited growing concerns about the economy as the leading reason for more stringent standards,” according to the report. “While the economic outlook was a main concern for all commercial products, it was particularly pronounced for commercial real estate (CRE) products.”

It added that for larger institutions, the disruption in financial markets during the 2007 second half had a significant impact on 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.

The report also noted that credit spreads also have risen sharply. Banks have emphasized maintenance financial covenants and lower borrower leverage, as well as increased guarantor support requirements, it added. More specifically, banks reported a sharp increase in their tightening of credit standards for a number of types of commercial real estate loans.

For commercial construction loans, nearly half (49 percent) reported tightening compared with just 13 percent the prior year, while just 8 percent reported easing, less than one third of the 29 percent that reported easing the prior year. In the “other commercial real estate” category, 25 percent reported tightening, up from 7 percent in 2007, while just 2 percent eased, way down from 20 percent the prior year.