Stern Warning from OCC As Banks Ease Underwriting
Loan growth is up moderately, and with it, competition among lenders for new business. Underwriting is easing as a result—and that has regulators concerned. July’s news was rife with stories warning financial institutions and investors to keep risk in the forefront as they ramp up the quest for profits in this recovery.
“I am… mindful of the potential for low interest rates to heighten the incentives of financial market participants to reach for yield and take on risk.” Fed Chair Janet Yellen
It’s been a long time coming for the market to be more willing to take on risk. And, a higher risk tolerance is not an entirely bad thing. It’s what finally moved investors off the sidelines and back into deal-making. It’s also what spurs business owners to hire again and invest in new office, retail and industrial space. And a higher risk tolerance got developers back in the game, too—but it also gets regulators concerned.
OCC Issues Mid-Year Warning
In late June, EDR Insight hosted a webinar on banks’ risk management titled “An Inside Look at the Challenges Facing Lenders and Appraisers Today.” During his presentation, Brian Ginter, Director of Diversified Real Estate Consulting Network, referenced the OCC’s Commercial Real Estate Lending guidance from August 2013, and urged attendees to have proper policies and procedures that reflect the OCC’s emphasis on appraisals and environmental risk management–and how they should interrelate. Shortly after our event, the OCC came out with a warning based on what its examiners characterize as a gradual erosion in underwriting standards as banks take on more risk in their lending practices.
The warning came within the pages of the OCC’s Semiannual Risk Perspective report. The good news is that the overall financial conditions of banks supervised by the OCC continue to improve as loan volumes ramp up–albeit modestly. The not-so-good news is that banks are easing underwriting standards due to competitive pressures and the need for revenue growth. Below is what the OCC sees as the key risk issues for large banks and midsize-community banks–and more importantly, the specific areas where these banks can expect to see heightened OCC supervisory attention:
Strong Words From the OCC’s Semiannual Risk Perspective:
“The OCC sees signs that credit risk is now building after a period of improving credit quality and problem loan clean-up. Examiners have observed erosion in the underwriting standards for syndicated leveraged loans, as well as loosening of standards and increased layering of risk in the indirect auto market. Recent examinations of commercial loan portfolios have identified an increase in policy and underwriting exceptions, including some examples of risk layering (e.g., increasing collateral advance rates, waiving or loosening of guarantees, and more liberal repayment terms such as extended periods of interest-only payments). A recent horizontal review of midsize and community bank asset-based lending (ABL) found evidence of gradually loosening credit policies in response to competitive pressures. Further, bankers are speaking out increasingly regarding their concern with competitive pressures. Given these trends, the OCC will increase its attention on underwriting standards and encourage banks to diligently assess their credit risk appetite in this stage of the credit cycle.”
Risk Management Has Come A Long Way
Regulatory pressures are intense, and the latest OCC report is just the latest sign of that trend. Examiner scrutiny since the market downturn has had a noticeable impact on how banks operate. While banks are drastically reducing operating costs in some areas, the number of risk managers is up significantly at some institutions since the financial crisis first shook the industry in 2008. Consider some interesting stats from a recent Wall Street Journal article:
• Wells Fargo has 2,300 employees in its core risk management department, up from 1,700 two years ago. The department’s annual budget has doubled to $500 million in the same period.
• The Federal Reserve Bank of New York has about 45 examiners, twice its pre-crisis level.
• Regional bank KeyCorp rewrote compensation guidelines so that loan officers can lose their bonuses if they don’t meet new risk management standards. Pre-crisis, bonuses were determined largely by profit goals.
• Senior risk officers earn as much as 40 percent more than they did a few years ago.
• Chief risk officers can earn roughly as much as a CFO or general counsel. Before the financial crisis, chief risk officers got about one-third less.
“Five years ago, if the risk group recommended against a strategy or product, it might just be one part of a debate. [Now] when we say no, it’s usually no.”
—Michael Loughlin, Wells Fargo & Co. chief risk officer, to the Wall Street Journal
The recent OCC report is just the latest sign that bank oversight will continue as regulators attempt to minimize the risk of another financial crash. Financial institutions regulated by the OCC can bank on increased attention on the areas highlighted in table above, including “the interconnectedness of risks and the importance of managing those risks in an integrated fashion throughout the entire bank.” Although most banks still largely manage risk in a siloed approach, but the pressure is building to approach all types of risk management more holistically by implementing system-wide programs that process risk management data and create a compliance trail for banks to show examiners.
FOR MORE INFORMATION
– The full Spring 2014 OCC Semiannual Risk Perspective report is full of graphs on bank financials, loan growth, risk metrics and trends in OCC enforcement actions. It focuses on issues that pose threats to the safety and soundness of those financial institutions regulated by the OCC and is intended as a resource to the industry, examiners and the public.
– These two sources underscore the findings in the OCC’s Semiannual Report:
1. OCC Survey of Credit Underwriting Practices
– All of EDR Insight’s past content on Lender Risk Management from EDR Insight