WASHINGTON — Despite near-constant warnings from regulators, large U.S. banks failed to anticipate the problems now roiling their commercial loan portfolios, the Federal Reserve Board said Friday.

The central bank’s third-quarter survey of senior loan officers found that among banks with $20 billion or more of assets, 64% said deterioration of their business loans in the past two years had been worse than expected. That includes 14% who characterized the weakening as “much greater” than predicted.

The Fed also surveyed foreign banks operating in the United States and found that 56.5% reported surprise at the increases of commercial credit delinquencies.

“That loud clicking sound you hear is banks ratcheting up their lending standards,” said Kevin M. Blakely, executive vice president of Cleveland-based KeyCorp.

Smaller banks reported less surprise at the increase in commercial loan delinquency rates. Half the respondents from banks with less than $20 billion of assets said the deterioration had been in line with expectations, and 30% said it was higher than expected. Only 5% of the smaller banks called the increase in delinquencies “much greater” than expected.

The survey results came out two days after Credit Suisse First Boston analyst Susan Roth predicted that worries about bad loans could drive bank stocks down as much as 25% in coming months. Earlier last week, both First Union Corp. and Bank of America Corp. shocked the markets by warning that they expected larger than usual loan chargeoffs in the fourth quarter. Each principally blamed a single bad loan to a large company.

Mr. Blakely of KeyCorp said that because the secondary market for loans was so liquid in the mid-1990s banks were able to get away with looser underwriting standards. But when the market for low-grade credits began to dry up, he said, “loans that you used to be able to refinance began sticking to the books.”

Regardless of their warnings the last few years, regulators were lenient about enforcing credit-quality standards before default rates began rising, Mr. Blakely said. And it is the loans made two or more years ago that are beginning to go bad.

“The thing about the regulators is that in 1997 and 1998 they were beating the drum about credit quality but it was just rhetoric,” he said. But this year, particularly in their annual examinations of large banks’ syndicated loans, “they stopped beating the drum and started beating the banks over the head with the drumsticks,” he said. “They are definitely getting a lot tougher.”

Caught by surprise by the decline in credit quality among commercial borrowers, banks are responding with tighter standards for initiating loans, though demand for commercial credit is reportedly dwindling.

Of all the banks surveyed, 35.1% reported a decline in loan demand from large and middle-market companies; only 12.3% reported an increase. The decline was more dramatic at large banks, where 45.2% reported weaker demand. Demand for loans by smaller businesses was down at 25.5% of the banks surveyed but up at 12.7%.

Just over half the large banks and one-third of small banks reported that, despite the decline in demand, they have tightened terms on loans to large and middle-market firms. One-third of large banks and 23.1% of small banks reported tightening loan terms to small companies.

Among the most common changes in loan terms were increased interest rates, premiums on risky loans, and fees for credit lines. Borrowers most affected by the changes include those with no prior relationship with the institution and those trying to finance mergers and acquisitions.

Most respondents also reported that standards are only going to get tighter. Slightly more than 50% said they expect to raise the bar still higher before the end of 2001.

No surprise there, said John Mingo, managing director of the credit risk consulting firm Mingo & Co.

“Banks look at marketwide default rates rising; they know it is likely that the current economic boom is going to come to an end; so they tighten underwriting standards and widen spreads,” he said.

Mr. Mingo, a former senior adviser to the Federal Reserve Board, said that though the numbers may look bad, there is no reason to worry about widespread bank failures such as those that occurred when default rates soared in the late ’80s and early ’90s.

“There is nothing in the data that suggests that the coming nonboom times are going to be worse than the last recession,” he said. “Banks are a lot better capitalized than they were a decade ago, and it is reasonable to say that they understand credit risk measurement and management better than they did a decade ago.”

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