OCC Report Discusses Risks Facing National Banks and Federal Savings Associations

Summary

Top risks facing national banks and federal savings associations include the lingering effects of a weak housing market, revenue challenges related to slow economic growth and market volatility, and the potential that banks may take excessive risks in an effort to improve profitability.

The Office of the Comptroller of the Currency discussed those risks in its new report, the Semiannual Risk Perspective for spring 2012, which was released today. Key points regarding these risks facing banks include:

• The overhang of severely delinquent and in-process-of-foreclosure residential mortgages continues to challenge large banks with extensive mortgage operations and continues to affect the economic environment for all banks.
• Increased operational risk is a key concern as banks try to economize on systems and processes to enhance income and operating economies. This risk may be amplified by the use of third-party products or distribution systems.
• Asset-quality indicators show continuing improvement across small and large banks. Small bank delinquency and loss rates did not reach the peaks seen at the larger banks, but their pace of improvement has been slower. Housing-related loans continue to demonstrate above-average rates of delinquency and charge-off. Commercial real estate performance is improving, but vacancy rates and the level of problem assets continue to be high.
• Outside of commercial and industrial lending, loan growth remains tepid, which has weighed on net interest income by pressuring asset yields for banks of all sizes. Underwriting standards are under pressure as banks compete for higher earning assets to improve profitability.
• The persistence of historically low interest rates continues to hamper margin upside, by limiting the ability of many banks to further reduce funding costs. As net interest income has declined, non-interest income faces pressures from legislative, regulatory, and market changes that have depressed fee income, servicing and securitization income, and may restrain future trading revenue.
• More generally, the low interest rate environment continues to make banks vulnerable to rate shocks. Small banks, in particular, are increasingly adding to investment portfolio positions and increasing duration to obtain higher yields. "New product" risk is increasing as banks seek to enter new or less familiar markets to offset declines in revenues from core lines of business.
• European sovereign debt issues and the threat of a break-up of the Euro have led to a sharp slowdown in European economic growth, contributed to worsening credit quality, increased financial market uncertainty, and perceptibly weakened global economic activity. These developments have contributed to an increase in the cost of long-term debt and equity financing for large European and U.S. financial institutions as these issues continue to weigh on market confidence and the economic recovery in Europe and the United States.

According to the report, levels of capital and allowance for loan losses across the industry are more robust and of higher quality than prior to the recession. The higher levels and better quality of capital are noticeable across the industry, but most notable at the largest banks. However, the U.S. banking industry continues to recover from the recent recession and to adjust to significant shifts in its operating and regulatory environments. These shifts are inducing large changes in the risk and profitability profiles of all banks, but may affect community banks differently than large banks. Combined, these conditions present significant operational risk for banks of all sizes.

The report presents data in four main areas: the operating environment; the condition and performance of the national 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 December 31, 2011. The OCC plans to release the report twice a year.