Competitive pressures and strategic and operational risks top the semiannual list of supervisory concerns in a report released by the Office of the Comptroller of Currency (OCC).
While conditions overall showed improvement in the second half of 2013, the OCC reported in its Spring 2014 Semiannual Risk Perspective that credit risk is building in supervised national banks and federal savings associations following a period of improving credit quality and problem loan clean-up.
Key findings from the report include the following.
Competition for limited lending opportunities is intensifying, resulting in loosening underwriting standards and that easing in underwriting and increased risk layering is also occurring in commercial loans.
The prolonged low interest rate environment continues to lay the foundation for future vulnerability. Banks that extend asset maturities to pick up yield could face significant earnings pressure and potential capital erosion depending on the severity and timing of interest rate moves.
Many banks continue to re-evaluate their business models and risk appetites to generate returns against the backdrop of slow economic growth and low interest rates.
Regarding commercial real estate
specifically, the OCC noted that the overall financial condition of community and midsize banks continues to improve. However, the earnings outlook for this segment of the banking industry, however, is less uniform. While earnings overall are improving because of loan growth, expanding business lines, and reduced provision and other real estate owned expenses, pressures persist at many small banks due to weak loan demand and declining investment yields.
According to the OCC, given expectations for an average pace of economic growth, most forecasts call for continued slow improvement in CRE market fundamentals.
Property prices remain below peak for all property types at the national level, but the apartment sector outperforms other property types because of superior fundamentals. Low interest rates and stronger fundamentals have allowed CRE prices to begin to recover, but forecasters expect minimal improvement in commercial property values over the next two years since higher interest rates will partially offset the impact from strengthening fundamentals.
The strongest growth within real estate lending was commercial mortgages to owners and lessors of residential property, mainly apartments. The OCC said it continues to emphasize the need for banks to ensure that they have the necessary expertise to understand the risks in the CRE sector.
The OCC said its examiners will focus on banks’ strategic business and new product planning to ensure appropriate risk management processes are established. And that its supervisory staff will evaluate the underwriting practices for new or renewed loans in banks’ commercial real estate portfolios for slippage in structure and terms.