Loan diversity among U.S. and Canadian banks has weakened over the past couple of years, according to a new report from Moody’s Investors Service.

“Compared with last year’s survey results, more banks showed deterioration in their loan granularity than improvement,” says Moody’s analyst Thuy Nguyen, one of the report’s authors. “We believe the survey’s indication of greater lending concentration is another example of weakening underwriting standards in response to heightened competition.”

Loan granularity is measured as percentages of core earnings, tangible common equity (TCE), and Tier 1 Capital. The analyst adds that the erosion of loan diversity is more notable when large single-client exposures are compared to core earnings (defined as earnings before taxes and provisions).

With 90 North American banks responding to both 2006 and 2007 surveys, 25 banks were able to improve their loan granularity, and 65 banks could not, Moody’s says. “On a TCE basis,” the analyst states, “38 banks improved and 52 banks got worse; in terms of Tier 1 Capital, 39 banks were better and 49 banks weakened.”

Moody’s also found that larger North American banks continue to display superior loan granularity when compared with smaller institutions – an outcome that is similar to previous years’ findings.

Moody’s senior vice president Sean Jones, the other author of the report, explains that Moody’s has recently implemented a revised methodology for estimating bank financial strength ratings, which has clearly benefited smaller U.S banks (those with assets under US$35 billion) in terms of loan diversity.

“Although loan granularity was a significant rating consideration in the past,” Jones says, “it should be noted that Moody’s has reduced the relative weight of this observation in its rating evaluations because of the new methodology governing bank financial strength.” He points out that the weighting of loan concentration is the same as those given to a bank’s industry concentration, risk management, and controls.