Jul 03, 2014
From the Financial Reporting View
The Office of the Comptroller of the Currency (OCC) recently issued its Semiannual Risk Perspective report (Spring 2014), which discusses the key risks faced by federally chartered banks and savings institutions (collectively, financial institutions).
The OCC report notes that the financial performance of the banking industry improved in 2013, setting a new record level of net income. However, net income was only 5% higher than the record set before the financial crisis, despite 20% growth in assets since the crisis. In addition, return on assets and return on equity remain below pre-recession peaks with small financial institutions lagging behind their larger counterparts. Revenue declined modestly in 2013, as lower net interest income more than offset modestly higher non-interest income. Sluggish loan growth and prolonged low interest rates continue to put pressure on net interest margins. The improvement in earnings continues to be largely attributable to lower provisions for loan losses and non-interest expenses, rather than organic growth.
The OCC also notes that traditional credit metrics improved significantly in 2013. The levels of non-performing assets and net charge-offs declined substantially and are now near or below pre-recession levels. Allowance for loan and lease losses (ALLL) releases were a common practice for many financial institutions in 2013, driven by the improvement in loan quality and only moderate portfolio growth. At the same time, however, the OCC sees signs that credit risk is now building after a period of improving credit quality and problem loan clean-up. For example, OCC examiners observed erosion in the underwriting standards for syndicated leveraged loans, and loosening of standards and increased layering of risk in the indirect auto loan market.
The key risk themes discussed by the OCC in the report include:
- Competitive pressures, the need for revenue growth, the ongoing low interest rate environment, and compliance challenges continue to complicate bank risk management.
Competitive pressures are leading to eased loan underwriting across a variety of products. ALLL releases continue despite the risk-building that is occurring in many loan portfolios (and, in view of these trends, ongoing ALLL releases are not a sustainable source of earnings). The increase in long-term interest rates in 2013 underscores the need for bank management to understand and quantify vulnerability to rising interest rates, with the prolonged low interest rate environment laying the foundation for future vulnerability. Bank Secrecy Act and anti-money laundering risks remain prevalent.
- Strategic risk remains high for many financial institutions, as management teams search for sustainable ways to generate target rates of return.
Many financial institutions continue to reevaluate their business models, deployment of capital, and risk appetites in view of the challenging operating environment. Some are taking on additional risks by expanding into new, less familiar, or higher-risk products. Some are lowering overhead expenses, often by reducing or outsourcing control functions to third parties (sometimes without appropriate due diligence), exiting less-profitable businesses, or closing offices.
- Operational risk remains high because of the volume and velocity of change to business models and operations, and continuing cyber-threats.
The volume and velocity of changes in technology systems and business processes continue to increase, which challenges the ability of financial institutions to manage the change process, ensure adequate resources, and maintain quality and controls. Financial institutions continue to be attractive targets of coordinated and sophisticated cyber-threats, which requires heightened awareness and appropriate resources to identify and mitigate the associated risks.
The OCC report also contains a significant amount of information about economic trends and conditions, banking industry financial and operating statistics, and regulatory actions.