It seems as though some lenders may be ready to cut their losses and move on, as the number of lenders who have offered struggling borrowers a principal reduction has begun to increase. The majority of modifications so far have come in the form of interest rate reductions and/or loan term extensions. Until recently, flat out principal reductions were rarely a consideration:

The portion of loan modifications in the second quarter that involved reducing the principal jumped to 10% from 3.1% in the first quarter, according to the report released Wednesday by the Office of the Comptroller of the Currency, or OCC, which regulates national banks.

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The Office of the Comptroller of the Currency (OCC) announced yesterday that federal bank regulatory agencies will begin their financial assessment of certain financial institutions to “estimate the range of possible future losses and the resources to absorb such losses over a two-year period.” Under the Capital Assistance Program (CAP), large banks, which collectively hold “roughly two-thirds of aggregate U.S. Bank Holding Company assets,” will be assessed under a baseline scenario of potential future economic developments, and also under a more severe set of potential circumstances referred to as an adverse scenario.

Regulators will weigh the institutions’ liabilities and assets against their capitalization. If regulators discover a deficit, the Treasury will provide whatever funds necessary to fulfill their capital requirement.

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Banks across the country are saying they’re stuck between a rock and hard place, as their regulators are sending them mixed signals. Being strongly encouraged to expand consumer lending, while informally being pushed to raise and hold extra capital has banks confused — further complicating the restoration o our financial system.

Federal Reserve Vice Chairman Donald L. Kohn addressed the “The Role of Regulators” earlier in December, when he spelled out both the increased actions by the Federal government designed to encourage lending, as well as the need for financial institutions to hold reserve capital.

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OCC News Release, 6-12-08:

The Office of the Comptroller of the Currency released today its 14th annual Survey of Credit Underwriting Practices and reported that commercial and retail underwriting standards tightened after four consecutive years of eased underwriting standards.

The 2008 survey included examiner observations and assessments of credit underwriting standards at the largest national banks. The survey reflected that the disruption in financial markets that began in 2007 led to an abrupt change in risk appetite of the majority of the banks and a renewed focus on fundamental credit principles by bank lenders.

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