OCC Report Focuses on Risks Facing National Banks and Federal Savings Associations

Summary

Key issues facing national banks and federal savings associations continue to involve the potential for banks to take excessive risk in an effort to improve profitability, revenue challenges from a slow economy and financial market volatility, and lingering effects of real estate lending.

The Office of the Comptroller of the Currency's Semiannual Risk Perspective for fall 2012 provided additional details on these risks facing the banking industry that include:

• Threats to business models from low rates, sluggish economic growth, and the historic volume of new banking regulations, remains high. OCC examiners will be focusing on how banks are responding to these pressures. OCC supervisory staff will focus on strategic business and new product planning to ensure that adequate consideration of safe and sound business practices, including potential compliance, operational and reputation risks, is evident.
• Underwriting standards remain under pressure as banks compete aggressively for limited, high-quality lending opportunities. Standards for leveraged loans have weakened over the past 18 months and yields on high-risk assets are at record lows. The underwriting of middle market commercial and industrial lending also shows signs of slipping as banks compete for new business.
• Credit quality improvement in bank portfolios is stabilizing. As a result, reserve releases, which have fueled growth in bank earnings, may likewise need to stabilize or decrease from recent levels.
• Compliance and reputation risks remain high as banks struggle to maintain investments consistent with higher market and regulatory standards. Bank Secrecy Act and anti-money laundering risks also are increasing as criminals become more sophisticated.
• Modest economic growth forecasts reflect the cumulative weight of soft U.S. labor markets, slower growth in emerging markets, and potential volatility from the Eurozone crisis and resolution of both near term and longer term U.S. fiscal policy challenges.
• Low interest rates seem likely to persist, keeping pressure on net interest margins, as older assets mature or default and are replaced with lower yielding loans. Once stronger loan growth resumes, any increase in net interest income may be offset by a faster-than-expected rise in funding costs and erosion in security portfolio value.
• Market volatility, economic uncertainty, and low interest rates present revenue growth difficulties for asset management businesses, which contribute significantly to non-interest income. Clients' risk aversion has dampened asset management revenues and has increased demand for lower revenue fixed-income instruments.
• Mid-year data show stabilization in the housing sector with modest price increases in selected markets. Construction permits are picking up, providing modest stimulus from a sector that has been hardest hit by the collapse of the housing bubble.
• Banks with extensive mortgage servicing operations have made progress in remediating standards and practices, but the financial and reputational costs remain high. Servicing fee income has increased because of high refinancing volumes driven by historically low rates.
• Commercial real estate exposures show improvement, but problem assets remain elevated. Risk concentrations at some banks heighten vulnerability to any additional economic stress.
• Maturities and amortization of home equity lines of credit are an emerging risk as loans reach the end of their draw periods and payments increase to meet amortization requirements. This transition will require more comprehensive analysis to ensure allowances for losses appropriately reflect the risk in these portfolios.

The report presents data in four main areas: the operating environment; condition and performance of the banking system; funding, liquidity, and interest rate risk; and regulatory actions. The report 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 general public. The report reflects data as of June 30, 2012.