Responding to competitive pressures, abundant liquidity, and the desire for yield in the low interest rate regime, banks have eased underwriting standards and enhanced levels of credit risks, reports an OCC survey.

The Office of the Comptroller of the Currency’s 20th Annual Survey of Credit Underwriting was released on Dec. 16 after the agency compiled observations of examiners and assessments of credit underwriting standards. The survey covered loans totaling $4.9 trillion and constituting approximately 94% of all loans in the federal banking system.

Easing of underwriting standards for third consecutive year

According to the survey, for the third consecutive year, underwriting standards have been eased within both commercial and retail products. The survey notes that as banks continue to reach for volume and yield to enhance margins and compete for limited loan demand, supervisors will focus on banks’ efforts to maintain prudent underwriting standards, monitor portfolio credit risk, and reduce exceptions to policy.

The OCC survey points out that the majority of banks (61%) show unchanged underwriting standards, while 34% of banks eased underwriting standards. This can be evidenced from the following table:

Commercial products underwriting trends

 

The survey results highlight that the easing of standards occurred primarily at large banks, continuing a trend from the past three years and comparable to the 2006 underwriting survey results.

Turning its focus onto retail products, the survey points out that a sustained trend of eased underwriting standards has been evident from 2010 through 2013, stabilizing at 22% of banks for 2013 and 2014. However, as can be deduced from the following table, at 68% of banks, the standards remain unchanged.

Retail product underwriting trends

 

The survey attributes the easing of standards to changes in the competitive environment, market strategy, risk appetite, and regulatory policy guidelines.

The survey notes that large banks, as a group, reported the highest share of eased underwriting standards. Leveraged loans, indirect consumer, credit cards, large corporate loans, and international loans experienced the most easing in standards and continued the trend from last year. As set forth in the following table, 48% of banks originating leveraged loans eased underwriting standards:

Leveraged lending

 

Enhanced credit risk

The OCC survey points out that the relative level of credit risk too has increased, with the commercial portfolio reflecting higher risk since the last survey. The survey notes the level of credit risk is anticipated to increase in both commercial and retail portfolios over the next 12 months:

Commercial credit risk

The following graph highlights the direction of change in retail credit risk:

Retail credit risk

The OCC survey notes increasing policy exceptions centered in commercial products. The agency cautions that the combination of increasing policy exceptions and easing underwriting standards can layer risk into loan portfolios that only surfaces during times of stress.

The OCC also points out that in view of the loosened standards, supervisory efforts will continue to focus on new product portfolios and those with increasing loan volumes. The survey suggests boards of directors and senior management should consider carefully the impact of the changing mix of more aggressively underwritten loans on the quality and volatility of performance in their loan portfolios.

See the full study here