Jul 20, 2015
From the Financial Reporting View
The Office of the Comptroller of the Currency (OCC) recently issued its Semiannual Risk Perspective report (Spring 2015), 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 federally chartered financial institutions was slightly weaker in 2014 compared with 2013. In 2014, net income returned to peak levels set in 2006 before the financial crisis, despite over $2 trillion (or 25%) growth in assets since the crisis, reflecting the challenges of the low interest rate environment. Return on equity declined in 2014 and remains below pre-recession peaks. Loan growth continued at large and small financial institutions, particularly commercial loans including multi-family commercial real estate (CRE) loans, commercial and industrial (C&I) loans, and loans to non-depository institutions. However, the increase in net interest income due to loan growth was not enough to mitigate a decline in noninterest income and an increase in noninterest expense.
The OCC also notes that traditional credit metrics continued to improve in 2014. For example, total loans 90 days or more past due or on nonaccrual declined further, but remain elevated compared with pre-recession levels, and net charge-off ratios have approached pre-crisis levels. The allowance for loan and lease losses as a percentage of total loans also has declined as credit quality improves, although the decline is slowing. At the same time, however, the OCC sees signs of increasing credit risk. For example, OCC examiners have observed weak underwriting standards for syndicated leveraged loans, and loosened standards and increased layering of risk in the indirect auto, asset-based, CRE, and C&I loan categories. Recent OCC examinations also have identified increases in policy and underwriting exceptions, and bankers continue to express concerns about the effects on underwriting standards of intensified competition. Almost one-half of outstanding balances on home equity lines of credit are scheduled to reach their end-of-draw periods in 2015-2017, thereby posing risks to borrowers including payment shock from additional principal payments and refinancing difficulties due to lower property values and more conservative underwriting standards.
Cybersecurity was listed as a top priority in the OCC’s Annual Report Fiscal Year 2014. Attack methods are often customized and continuously evolving in response to banks’ mitigating controls, and allow attackers to compromise customer, employee, or third-party credentials used to steal data or disrupt bank payments and processes. In view of the rise in high-profile data breaches and continued risks of cyber threats, the OCC and other regulators have worked to raise awareness and increased their supervision of cybersecurity.
The key risk themes discussed by the OCC in the Spring 2015 report include:
- Competitive pressures, the search for revenue growth, and the ongoing low interest rate environment continue to challenge bank risk management and influence risk appetite.
- Strategic risk remains high for many financial institutions, as management teams search for sustainable ways to generate target rates of return or struggle to implement their strategic plans.
- Operational risk is high as banks adapt business models, transform technology and operating processes, and respond to increasing cyber threats.
Profitability and growth pressures are causing financial institutions to reassess credit risk tolerances and underwriting standards. Competitive pressures are leading to eased loan underwriting across a variety of products. The prolonged low interest rate environment continues to lay the foundation for future vulnerability. The continued post-crisis deposit inflows and shifts in deposit mix are amplifying interest rate risk management complexities.
The challenging operating environment is causing many financial institutions to reevaluate their business models, deployment of capital, and risk appetites. 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. Financial institutions continue to face competitive pressures from nonbank firms expanding into traditional banking activities.
Increasing pressures are causing bankers to evolve their business models to launch new products, leverage technology, increase reliance on technology and automated controls, reduce staffing, outsource critical activities, and re-engineer business processes. Financial institutions continue to be vulnerable to cybersecurity attacks that can compromise data, systems, or personally identifiable information.
The OCC report also contains a significant amount of information about economic trends and conditions, banking industry financial and operating statistics, and regulatory actions.