Why it matters
In two recent speeches, Comptroller of the Currency Thomas J. Curry discussed the supervisory priorities of the Office of the Comptroller of the Currency (OCC), including bank operational risks, increased credit exposures and insufficient loan loss reserves. In one speech, the Comptroller focused on risks associated with non-prime auto loans packaged as asset-backed securities. In another speech, Curry expressed concern that conscious decisions by banks to increase their risk appetites are the result of increased competition and are worrisome. Most particularly, the Comptroller identified concentration risk as a reason for concern. For example, too much concentration on non-prime auto loans—like subprime mortgages just a few years prior—could put lenders and the market at risk. "[W]hat is happening in this space today reminds me of what happened in mortgage-backed securities in the run up to the crisis," the Comptroller said, noting the relaxed underwriting standards and extended maturities currently available for car loans. "Although delinquency and losses are currently low, it doesn't require great foresight to see that this may not last. How these auto loans, and especially the non-prime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry." The Comptroller noted that commercial real estate loans, especially in the construction and multifamily housing sectors, are also on the OCC's radar. Banks should prepare themselves for increased attention from examiners with regard to these loans.
Detailed discussion
The Comptroller discussed the never-ending importance of operational risk, a lesson learned from the recent financial crisis, when the industry paid "a heavy price for dropping the ball" on both compliance and operational risk. "[W]e all need to do a better job at identifying significant operational risks that otherwise seem mundane," Curry said. "If these activities or processes have the potential to pose significant or serious reputational, legal or financial risks, just like credit risk and cybersecurity, they cannot be neglected no matter how pressing other needs may seem at the time."
Curry said the cycle has reached a point where credit risk is moving to the forefront. As banks reach for loan growth and ease underwriting standards, "it's a time when supervisors and bank risk officers need to be most vigilant," he warned.
The Comptroller noted that auto lending represented more than 10 percent of retail credit in OCC-regulated institutions in the second quarter of 2015, up from 7 percent during the same time period in 2011. Increasingly, banks are packaging these loans into asset-backed securities rather than holding them in a portfolio, Curry said. In turn, the securities are being greeted by strong demand from investors.
"But what is happening in this space today reminds me of what happened in mortgage-backed securities in the run up to the crisis," the Comptroller said. "At that time, lenders fed investor demand for more loans by relaxing underwriting standards and extending maturities." In the current auto loan market, 30 percent of all new vehicle financial loans feature maturities of more than six years, and borrowers can obtain a car loan even with very low credit scores, he noted.
"With these longer terms, borrowers remain in a negative equity position much longer, exposing lenders and investors to higher potential losses," Curry explained. "Although delinquency and losses are currently low, it doesn't require great foresight to see that this may not last. How these auto loans, and especially the non-prime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry."
The Comptroller was quick to point out that neither home equity loans nor auto loans are inherently unsafe. "However, what is inherently unsafe are excessive concentrations of any one kind of loan," Curry said. "You don't need a very long memory to recall the central role that concentrations—whether in residential real estate, agricultural land, or oil and gas production—have played in individual bank failures and systemic breakdowns. It's an old movie that's been reprised on a regular basis."
For this same reason, the OCC is also closely watching growing exposures in commercial real estate loans, particularly in the construction and multifamily housing sector, Curry told attendees, as well as loans to non-depository financial institutions.
The Comptroller expressed the hope that "banks would take the initiative to address concentration risk on their own, without supervisory action," citing the guidance issued in December 2006. Moreover, the Comptroller suggested that "every bank should be taking a hard look at the loan loss allowance, and asking if it's appropriate for the level of risk their institution is taking on." Moreover, the Comptroller noted that the environment is changing. "We're seeing loan growth in all asset categories, greater risk acceptance, weaker underwriting, and growing asset concentrations."
How is the OCC dealing with these risks? A "conscious strategy of identifying emerging concerns before they become entrenched problems," Curry said, with a focus on transparency and accountability. The agency's Semiannual Risk Perspective and supervision operation plan both offer a spotlight on areas of focus for the OCC (transparency) and a way for the media and the industry to take the regulator to task for its failure to take appropriate action (accountability).
"Looking back, it's clear that all of us made mistakes in the run up to the financial crisis—regulators and financial institutions alike. And I believe all of us recognize we have to do better," Curry concluded. "[T]he best way to avoid major disruptions down the road is to take sensible and tough-minded steps now. And that, I can promise you, we are doing."
To read the Comptroller's prepared remarks, click here.
To read the Comptroller's speech before the RMA Annual Risk Management Conference in Boston, MA, on November 2, 2015, click here.
