As mortgage lending increases with the improving economy, banks need to be careful about growing credit risk and must exercise reasonable caution in their lending decisions.
That was the message Comptroller of the Currency Thomas J. Curry had for banking officials during the Risk Management Association’s annual conference in Boston in November.
Speaking at the RMA conference, Curry said bank lending has increased steadily over the past two years with the improving economy and low interest rates.
“Banks are generally profitable,” he said. “They have seen steady growth in loan demand over the past 18 months, and many have worked with their regulators to resolve most of their compliance miseries, although often at a substantial cost. Although compliance risk remains high, banks are adapting to the new regulatory requirements.”
Curry said some lending growth is being driven by consumers doing better financially than they were in the years immediately following the financial crisis of 2008, but “many banks have made the conscious decision to increase their risk appetite and take on additional credit risk.
“They are doing this in part because in times of economic growth banks feel confident they can,” he said. “But they are also targeting less creditworthy customers and offering easier terms and conditions because they feel they must, in order to hold their own against the competition for loan growth, market share and revenue.”
According to Curry, OCC examiners have reported a relaxation of underwriting standards by the banks they supervise since 2012.
“Margins are thinner, productive covenants are weaker or nonexistent and loan maturities are longer,” he said. “In addition, banks are increasing their participation in riskier products, such as leveraged lending. The pattern I’m describing is common during the later stages of the economic cycle, which happens to be where we are today. But it also signals a rise in credit risk that bank risk officers must be aware of. Banks always face a risk that rising interest rates or deterioration in one or more sectors of the economy could impair loan performance even in well-managed portfolios.”
Curry voiced concerns about increased loan concentrations in certain industries. He also said banks should take a look at their loan-loss allowance ratio to make sure it’s appropriate for the level of risk they’re taking.
“We’ve been through a long period in which banks have been steadily reducing reserves,” he said. “Just over the last two years, the key ratio of loan-loss allowance to total loans dipped by more than 40%.”
While banks have argued the improved economy and strength in consumer lending justify a reduction in reserves, Curry said drawdowns of that magnitude are disproportionate.
“We’re seeing loan growth in all asset categories, greater risk acceptance, weaker underwriting and growing asset concentrations,” he said. “Growth rates in commercial real estate, for example, are above 14% year-over-year for OCC-supervised community and midsize banks, which are the banks that have the highest commercial real estate concentrations. Loans for multifamily housing also represent a growing concentration for many banks, a segment that could see deterioration as interest rates rise and refinance risks increase. It’s crucial that these and other concentration are soundly managed, supported by adequate capital, and properly reserved for. It’s clear to me that these reserves need to rise to account for the increasing credit risk we are seeing in the system.”
Read Curry’s complete remarks on the OCC website at http://www.occ.gov/news-issuances/speeches/2015/pub-speech-2015-147.pdf.
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