OCC cites loosening of underwriting standards as a top supervisory concern
On June 30th, the OCC released its Semiannual Risk Perspective for Spring 2015. The report, based on data through the end of 2014, discusses risks facing national banks and federal savings associations, and focuses on issues that pose threats to the safety and soundness of those OCC-regulated institutions.
According to the report, the financial performance of federally-chartered banks was slightly lower in 2014 compared to 2013 as a result of lower profitability. For example, net income declined 4 percent year over year. Interestingly, 2014 net income actually matched the pre-recession high set in 2006 – but on $2 trillion more in assets. The OCC cites the low interest rate environment as the main cause.
Overall, smaller banks (those with less than $1 billion in assets) outperformed larger banks in loan growth – 6.5 percent versus a 3.5 percent growth rate for those over $10 billion in assets. Mid-tier banks (those between $1 billion and $10 billion in assets) preformed similarly to their smaller counterparts, showing 6.4 percent loan growth during the same period. The growth at smaller banks is led by commercial and industrial (C&I), commercial real estate (CRE) and residential mortgage lending. Important to note, though, is the fact that not all smaller banks saw growth – 25 percent of reported either no growth or a decline over the past year.
Despite the mostly positive growth news, the OCC continues to see a loosening of underwriting standards. Citing a January 2015 report by the Federal Reserve, Senior Loan Officer Opinion Survey on Bank Lending Practices, the OCC highlighted respondents’ main reason for the net easing of standards: more aggressive competition from banks and nonbank lenders. In the survey, most reported “easing spreads, interest rate floors, and cost of credit lines” as a result.
Recent OCC exams of commercial loan portfolios have found increases in underwriting and policy exceptions and examples of risk layering, including waiving or loosening guarantees, more generous repayment terms and increasing collateral advance rates.
In particular, the easing of CRE underwriting standards is concerning. According to the OCC, “amortization schedules have lengthened, and the number of loans structured with either partial interest-only payments or full interest-only payments has increased.” More loans are being structured with limited or no guarantees, and banks are also becoming reliant on “low loan-to-value ratios to mitigate other concessions in structure and terms.”
Looking ahead, the OCC has supervisory concerns with growth in concentrations, easing in underwriting criteria and the impact “rising interest rates may have on the value of real estate collateral and its repayment capacity.” The OCC suggests when banks are managing their loan portfolios through this stage of the credit cycle that they regularly assess their credit risk appetite.
Banks that are looking to balance easing standards with safety and soundness should ensure they have a strong credit risk culture that establishes standardized processes and policies across the institution. For more on the topic, access the recorded webinar: Instilling the Right Credit Risk Culture.
