Surprises in OCC's Examination Priorities for 2016? Careful Innovation, Cybersecurity, Criminal Avoidance, Nonbank FI Lending

Manatt, Phelps & Phillips, LLP

Why it matters

Comptroller Thomas J. Curry underscored key 2016 supervisory concerns for his agency in a mid-December industry call discussing the OCC's latest Semiannual Risk Perspective report. His list includes the "usual" risks related to strategic, compliance, and interest rates as well as cybersecurity and underwriting standards. He urged national banks and federal thrifts to address strategic challenges of a slow-growth, low interest rate environment by continuing to evolve, adapting their business models, offering new products and venturing into new markets while performing appropriate due diligence. The report also highlighted continuing Bank Secrecy Act and anti-money laundering (BSA/AML) risk as criminal behavior and the use of technology evolve, and concern about the easing of credit underwriting standards and practices by banks and thrifts, particularly in markets such as indirect auto and commercial real estate lending. Resiliency planning for cyber threats remains a worry for the agency, as well as the ongoing low interest rate environment.

Detailed discussion

Summarizing the financial performance of national banks and federal savings associations through June 30, 2015, the Office of the Comptroller of the Currency (OCC) noted several positive trends in its latest Semiannual Risk Perspective. As compared to the first six months of 2014, financial institutions were stronger and experienced a 7% increase in net income, with a rise in profitability as measured by return on equity for both small and large banks.

While acknowledging the growth, the regulator said its primary supervisory concerns remain "generally unchanged," with strategic, underwriting, cybersecurity, compliance, and interest rate risks the top issues for the agency.

In remarks accompanying the release of the report, Comptroller Thomas J. Curry emphasized "the growing risk" posed by weakening credit standards.

"As the economic cycle turns, we see banks and thrifts reaching for yield and growth, sometimes extending their reach at the expense of sound underwriting, strong risk management, and adequate loan loss provisioning," he said. "OCC examiners will be paying close attention to each of those areas in the coming months," as "the warning lights are flashing yellow" in the area of credit risk. "Regulators and bank management need to act now to prevent those risks from becoming reality. We can't afford to wait until the warning lights turn red."

The report documented the third consecutive year of underwriting standards slipping, with banks and thrifts relaxing their requirements, layering risks in consumer and commercial lending products, and accumulating concentrations, particularly in commercial real estate and the indirect auto lending market.

This trend is due in part to the competitive pressures of the banking industry and the current slow-growth, low interest rate environment, with some financial institutions struggling with the strategic challenge of growing their revenue, the OCC recognized.

"Generally, we are seeing banks continue to make concessions on pricing, weaker or non-existent loan covenants, and maturities lengthening," Curry said, introducing risk at origination. "Bankers with long memories will remember the worst loans are made in the best of times, and the growing credit risk in their banks should be managed very closely."

The OCC recommended that banks assess their interest rate risk exposure under a variety of scenarios specific to the bank's own risk and complexity as well as consider the risk that the large deposit growth that occurred during the recession could potentially change quickly as rates rise. "The ongoing low interest rate environment continues to lay the foundation for future vulnerability," the report cautioned.

Curry highlighted the "dramatic increase" in lending to nondepository financial institutions as an area that has the agency's attention, with such loans increasing by more than 217 percent over the past three years. Because these borrowers engage in activities that are similar to the bank's own lending, "the risk from these loans can be highly correlated to the banks' risk and lead to concentrations," the Comptroller noted. "That is why we are encouraging bankers to monitor any concentration risk from these loans and ensure they clearly understand the underlying business model of these companies."

Another area of concern: oil prices. After hitting a pricing low not seen in years, the OCC said it expects to see losses from energy loans in the coming months, with certain regions (such as Colorado, Louisiana, North Dakota, Oklahoma, Pennsylvania, Texas, and Wyoming) hit harder than others.

Banks and thrifts cannot lose sight of the continued risk associated with cybersecurity and compliance, including BSA/AML requirements, the OCC noted, as technology and criminal behavior continue to evolve.

The report summarized the steady decline in enforcement actions from a peak in 2009, with matters requiring attention (MRA) also being reduced for the third consecutive year. For large banks, the top five categories for MRA are credit, capital markets, BSA/AML, consumer compliance, and information technology. The list for community banks is the same, with the addition of enterprise governance and exclusion of capital markets.

Looking to enforcement efforts in the coming year, Comptroller Curry said the agency will hew closely to the concerns expressed in the report. "[O]ur priorities for large bank examiners include governance and oversight, credit and underwriting, and in the area of compliance, we'll focus on cyber, BSA/AML, fair access, and operational risk," he explained. "For community banks, examiner priorities include strategic planning and governance, underwriting, interest rate risk, as well as the compliance issues mentioned for large banks."

To read the Semiannual Risk Perspective, click here.

To read OCC Comptroller Curry's remarks, click here.

Written by:

Manatt, Phelps & Phillips, LLP

Manatt, Phelps & Phillips, LLP on:

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