The Office of the Comptroller of the Currency (OCC) (1) charters, regulates and supervises national banks and federal savings associations. This Northeastern District (NED) meeting encompassed banks within OCC supervision and covered geographic areas inclusive of NY, LI, Northern NJ, Hartford, Stamford, DC, MD, VA, Boston, Pittsburg, Richmond, Norfolk, Charlotte and Raleigh. Items of concern somewhat mirrored the those expressed in the OCC Semiannual Risk Perspective generated in the Fall 2016. The meeting was held in NYC and was attended by various regional OCC officers. The top risk items for discussion included Strategic, Credit, Operational and Compliance.
Strategic Risk focused on the challenges to maintain management depth, expertise and succession choices; pressure to improve earnings and reduce operating costs; and, some unexpected entrance into or expansion of higher-risk ventures. Credit Risk topics included Commercial Loan growth, increasing concentrations, sustainability of market prices on income-producing real estate and impact of increased rates. Operational Risk covered Cyber threats, weak due diligence on new systems and increased reliance on vendors without third party management processes. Compliance Risk topics included lack of compliance expertise, implementation of regulation changes, increased scrutiny of CRA activities and high risk BSA activities.
This synopsis will concentrate on Credit related issues and put forth the ongoing concerns of the OCC related thereto. The regulatory agencies periodically announce and highlight their current risk concerns and expect this effort to impact present and future decision making with respect to the overall development and ongoing management of the banks’ commercial loan portfolios. Market comments arising from this meeting showed robust commercial real estate loan growth at North Eastern District institutions for all of 2016 and multifamily exposure above 50% of risk-based capital up substantially during the same period.
Some interesting statistics from the meeting regarding concentrations reflect negatively for those institutions with certain heavy concentrations versus Capital. It is noted here that, as of September 30 2016, 64% of the institutions that exceeded benchmarks for RE exposure and construction loan exposure have MRAs related to concentration risk management. (The benchmarks of 300% vs. capital for overall RE exposure, 50% CRE loan growth over previous 36 months and 100% vs. capital for construction loan exposure were established by the OCC in 2006 (2) and continue to be maintained today.) Specific to the concentration concern, during the three year economic downturn (2008 to 2011) 23% of banks that exceeded all three thresholds failed. As of 12/31/16 CRE concentrations are highest in Community Banks as compared to large and mid-size institutions. OCC cautions that despite lending institutions having appropriate policies, current robust market and scenario analysis and effective MIS in place …. But the OCC directly stated that “NONE OF THIS WILL SAVE YOU IF YOUR CONCENTRATION IS TOO HIGH!”
Risk Management Expectations expressed within the meeting included Board and Management Oversight to identify and quantify the nature and level of risk, Portfolio Management via a strong management information system, Market analysis for various property types and geographic markets, Credit Underwriting Standards to reflect the Board’s risk tolerance, Portfolio Stress Testing to assess concentration risk relative to earnings and capital and Credit Risk Review function which is critical for an institution’s self-assessment of emerging risks.
It was noted at the meeting that the Credit Risk Review function is not limited to an assessment of the bank’s risk-rating system. Within this process CEIS reviews appropriate levels of portfolio reserves and specific reserves, looks for adequate and timely monitoring of the bank’s loan portfolio via periodic internal reporting, especially with respect to Criticized and Classified loans, notes exceptions to existing Commercial Loan Policy, checks portfolio performance and reviews underwriting standards that should conform to Board approved threshold guidelines. Additionally, CEIS will remark on the RR assigned to individual loans or relationships as to its appropriateness based on Board approved definitions for the various grades. ALLL Methodology Validation and or Refinement can be performed by CEIS along with Stress Testing implementation or validation of existing in-house stress testing programs. At the request of the client bank CEIS can review the existing Commercial Credit Loan Policy for conformity to regulatory guidelines.
OCC is urging banks here to not let their competition set their underwriting standards.
Regarding the calculation of ALLL there was an overview discussion centered on CECL (Current and Expected Credit Loss) model which will be implemented for Public Business Entities (PBE) effective for Fiscal years after 15 December 2019. PBEs are essentially SEC filers that have issued debt or equity securities. Non PBEs will have an additional year before adapting to the CECL model. The “broad brush” discussion of CECL changes reported that there would be a reduction in the number of impairment models and that there would be earlier recognition of credit losses. OCC is urging banks to develop a plan for CECL including discussions with the board of directors, external auditors, industry peers and respective banking regulators.
In other words, be ready at implementation date!
Despite continued overall positive trends in credit quality metrics, it was noted at the meeting that credit expansion is being impacted by fierce competition resulting in loosening underwriting standards and increased risk appetite is resulting in growing concentrations. Reading between the lines there is more than a subtle allusion by the OCC to the saying that “history tends to repeat itself” and that financial institutions should make every effort to not be influenced by rigorous competition in order to make projected book which could result in higher concentrations at increased credit risk levels.
The area of principal concern is the steady upward progression of RE exposure at all size banks and especially at the Community Bank Sector.