Comptroller of the Currency John C. Dugan is voicing concerns that many retail lenders have relaxed their underwriting standards, offering borrowers more home equity loans with high loan-to-value ratios and longer interest-only periods, and backing piggyback loans to avoid mortgage insurance requirements.
A new survey of underwriting practices at 73 of the nation’s largest banks by the Office of the Comptroller showed 26 percent eased their standards for residential mortgage lending in the last 12 months. The banks granted an increased number of nontraditional home equity loans, including interest-only and payment-option adjustable-rate mortgages, lowered scorecard cutoffs, and offered more piggyback loans to avoid mortgage insurance requirements.
Banks, citing the need to remain competitive, eased standards for home equity lending “considerably further than indirect consumer lending,” the survey found.
The survey of underwriting practices included banks that hold about 90 percent of U.S. loans, and is based on the opinions of on-site government bank examiners, not self-assessments by banks themselves or third-party observers.
Over the past 12 months, the examiners concluded that 31 percent of banks surveyed took on more risk in conventional home equity loans, and forecast an increased risk at 49 percent of reporting banks in the next year. For the 26 percent of surveyed banks reporting high loan-to-value home equity lending, examiners estimated increased risk in 37 percent of the banks over the past year, and are forecasting increased risk in 47 percent of the banks over the next 12 months.
Examiners cited rising interest rates, concerns over a potential downturn in property values, and general portfolio seasoning as factors behind the increased risk. None of the banks surveyed decreased the level of risk in their underwriting practices for home equity products in the past year.
That’s surprising, Dugan said in a recent speech to members of the American Bankers Association, because with the “cooling of the red-hot housing market” regulators would normally expect lenders to tighten their underwriting standards and require borrowers to provide more equity.
The survey concluded that competitive pressures have pushed banks to ease commercial and retail commercial underwriting standards for three years in a row.
“What the underwriting survey says this year should give us pause,” Dugan said. “Loan standards have now eased for three consecutive years. The reasons most frequently cited are competition, often from nonbank investors, and optimistic — perhaps too optimistic — expectations for loan volume, yield, and market share.”
Whatever the reasons, Dugan said examiners are seeing “thinner pricing, reduced amortization, weaker covenants and controls, and pervasive structural concessions in such terms as tenor and guarantor requirements. Even where the bank’s lending policies have not changed, we are seeing an increased volume of exceptions to those policies. And, according to our examiners, these trends apply across both commercial and retail lending.”
Credit quality and allowances for loan losses remain strong, so a crisis is not imminent, Dugan said.
“In presenting results such as these, we are always mindful of the need to avoid painting a darker picture than is warranted, or ringing a warning bell that doesn’t yet need to be rung. It is not my intent to do either of those things today,” Dugan said. “On the other hand, none of us can afford to overlook or minimize symptoms that historically have been reliable predictors of future problems if not addressed.”
The Office of the Comptroller and other federal bank regulators issued new guidelines on Sept. 29 directing banks to tighten underwriting and disclosure standards for nontraditional mortgages. But the guidelines, which instruct banks to use the fully indexed rate when analyzing a borrower’s ability to repay interest-only mortgages and payment-option, negative amortization loans, apply only to federally insured banks.
In another speech this week, Dugan said states must follow the federal government’s lead and institute similar requirements.