Banks' Efforts to Turn Profits are Risky -OCC

The Office of Comptroller of the Currency’s (OCC) National Risk Committee (NRC) pronounced the financial positionrnof federally chartered institutions “improved” last year in its Semiannual Risk Perspective issuedrnon Wednesday.  The federal banking systemrnset a new record level of net income that was only $5 billion or 5 percentrnhigher than the previous pre-financial crisis record set in 2006 and it tookrnseven years and $1.5 trillion or a 20 percent growth in assets to achievernit.  This, the report said, highlightsrnthe slow pace of the recovery.</p

ThernPerspective presentsrndata in five main areas: the operating environment; the condition andrnperformance of the banking system; key risk issues; elevated risk metrics; andrnregulatory actions.  It focusesrnon issues that pose threats tornthe safety and soundness of banks ratherrnthan opportunities that banks may encounter at the same time. The report reflectsrndata as of December 31, 2013.</p

While conditions overall showedrnimprovement in the second half of 2013, the OCC reports that credit risk isrnbuilding in supervised national banks and federal savings associationsrnfollowing a period of improving credit quality and problem loan clean-up. Competitivernpressures, and strategic and operational risks top the list of supervisoryrnconcerns.  Essentially, the OCC is saying banks’ efforts to make a profit in light of increased regulatory costs and low-volatility market conditions are risky.</p

Return on assets and on equity remain below theirrnpre-recession peaks.  The federal systemrnas a whole returned almost 10 percent on equity but small institutions arernlagging behind large ones.  Revenue wasrndown as lower net interest income more than offset slightly higher noninterestrnincome and sluggish loan growth and low interest rates weigh on net interestrnmargins.  Improvements in earnings arernstill coming more from lower noninterest and provisions expenses rather thanrnreal growth. In addition, banks continue to face competitive pressure from nonbank firms seeking tornexpand into traditional bankingrnactivities.</p

Intensifying competition for lendingrnopportunities is causing banks to loosen underwriting standards especially inrncommercial loans, indirect auto, and leveraged lending.  Risk layering is also a concern in commercialrnloans.  While not widespread, somernexaminers have noted multiple policy and underwriting exceptions on individualrncredit decisions which OCC and Federal Reserve Board surveys of lendingrnpractices have confirmed.</p

Thernincrease in long term interestrnrates in 2013 underscores the need to understand and quantify banks’ vulnerability tornrising interest rates.  Somernbanks have reached for yieldsrnto boost interest incomernwith decreasing regardrnfor interest rate or credit risk.rnFor example, banks that extend asset maturities tornincrease yield could face significant earningsrnpressure, especially if relyingrnon the stability ofrnnon-maturity deposit funding in a rising rate environment,</p

Slowrneconomic growth is pushing banks to reevaluate business models, capitalrndeployment, and risk appetites and some are on taking on additional risks byrnexpanding into new, less familiar, or higher risk products.  OCC says its examiners will focus on strategicrnbusiness and new product planning to monitor risk management processes.rn</p

Some banks arernlowering overhead expenses,rnoften by reductions inrncontrol functions, exiting less profitablernbusinesses, closing offices, andrnoutsourcing critical control functions to third parties,rnin some instances without appropriate levels of due diligence. </p

Cyber-threats continue to evolve,rnrequiring heightened awareness and appropriate resources to identify andrnmitigate the associated risks.</p

Financial asset prices havernexperienced very low volatility for an extended period. As a result, measuresrnof price risk, such as value-at-risk, are at very low levels. The reducedrnwillingness of dealers to hold securities in inventory, due to capital andrnother concerns such as a change in monetary policy, could contribute to greaterrnprice swings going forward and increased price risk.</p

BankrnSecrecy Act (BSA) andrnanti-money laundering (AML) risks remain serious concerns asrnmoney-laundering methods evolve and the volume and sophistication of electronicrnbank fraud increases.  These risks have grownrnamong community banks during the last few years because of increases in thernnumber of higher-risk, cash intensive customers and internationally orientedrntransactions.  BSA programs at some banksrnhave failed to evolve or to incorporate appropriate controls into new productsrnand services.  </p

The report makes only a few brief mentions of thernresidential loan sector, citing shrinking refinancing activity as a risk factorrnfor smaller banks and that charge-offs of residential loans has decreased whilerndelinquencies among HELOCs has increased. rnThe one section devoted to residential mortgages notes that the declinernin new foreclosure activity has helped to offset slowing mortgage originationrnactivity.  Foreclosure starts for bothrnprime and subprime loans fell indicating that the market is stabilizing butrnalso attributed in part to the improving economy and aggressive foreclosurernprevention actions.  </p

Mortgage originations started out the year strong butrnrising interest rates caused activity to falter starting in May.  With improvements in job creation, incomerngrowth, and household formation lagging, demand for mortgages remains low.

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