Low interest rates contributing to tight lending standards

by Broderick Perkins

(1/4/2013) - Unfortunately, mortgage borrowers can't eat their cake and have it too.

Underwriting rules likely won't ease until record-level interest rates rise, according to Office of the Comptroller of the Currency's (OCC) Semiannual Risk Perspective for fall 2012, which paints a grim picture for lending institutions.

"Threats to business models from low rates, sluggish economic growth, and the historic volume of new banking regulations, remains high," the report begins. Sluggish Economy!

Citing a litany of obstacles, mortgage borrowers probably don't want to hear, the report says banks have a long way to go before underwriting standards ease and higher interest rates are in the mix.

"Banks with extensive mortgage servicing operations have made progress in remediating standards and practices, but the financial and reputational costs remain high," the report says.

While income from servicing fees have risen due to refinancing triggered by historically-low rates, that hasn't been sufficient to offset historic levels of new regulations - which lenders pretty much brought on themselves - as well as slow economic growth and other factors.

"Underwriting standards remain under pressure as banks compete aggressively for limited, high-quality lending opportunities," the report says.

Other highlights of the OCC report include the negative impact of:

• Economic uncertainty. Economic growth forecasts are modest at best, 2 to 3 percent per year. Soft labor markets, the Eurozone crisis and the U.S.'s own fiscal policy challenges weigh on banks bottom line.

• Housing sector. One of the brightest spots in the report, mid-year housing data reveal stabilization and recovery in housing with modest price increases in a growing number of markets. Construction permits are picking up, but only providing "modest stimulus" from one of the hardest hit economic sectors.

• Low interest rates. Ironically, what's driving most home buyers to market are low interest rates, but low rates put pressure on lenders' net interest margins. Margins shrink as older assets mature or default only to be replaced with lower yielding loans. Still there's pressure for rates to sink even lower.

• HELOC hell. Mounting home equity loans are reaching their end of draw period when payments increase to meet amortization requirements. That poses the risk of another wave of mortgage failures, forcing banks to adjust for the losses so portfolios adequately reflect the risk.

• Commercial real estate. Commercial real estate is also improving, but many lenders retain problem assets. Commercial real estate risk concentrations at some institutions increase their vulnerability to economic hiccups.

• Crime. More sophisticated criminals heighten compliance and reputation risks. Banks struggle to maintain investments consistent with higher market and regulatory standards.

"Key issues facing national banks and federal savings associations continue to involve the potential for banks to take excessive risk in an effort to improve profitability, revenue challenges from a slow economy and financial market volatility, and lingering effects of real estate lending," OCC reported.