WASHINGTON — Credit risk is once again taking center stage with regulators after several years in which they warned banks about operational risk and other threats.
While regulators say they haven't seen a precipitous decline in credit standards yet, they said banks need to have a plan in place to spot any trouble signs.
"While I have no intention of letting up in our emphasis on operational risk, we are reaching that point in the cycle where credit risk is moving to the forefront," said Comptroller of the Currency Thomas Curry in a speech Wednesday at the Exchequer Club.
"It's the point in the cycle where we customarily see an easing of loan underwriting standards, as banks drop or weaken protective covenants, extend maturities, and take other steps to build market share. It's also a time in which we see banks develop larger loan concentrations, without concurrent increases in reserves. It's a natural byproduct of competition during the later stages of the economic cycle, and so it's also a time when supervisors and bank risk officers need to be most vigilant."
Curry specifically cautioned about the recent build-up in auto loans, which accounted for more than 10% of retail credit for OCC-regulated banks in the second quarter, up from 7% in the same period in 2011. He was particularly concerned with how banks were originating longer term loans and then packaging those loans into asset-backed securities to attract investors.
"Today, 30% of all new vehicle financing features maturities of more than six years, and it's entirely possible to obtain a car loan even with very low credit scores. With these longer terms, borrowers remain in a negative equity position much longer, exposing lenders and investors to higher potential losses," Curry said. "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."
Still, Curry noted some improvements banks have made in addressing credit quality since the financial crisis, such as reducing exposure to home equity lines of credit that are now up for maturity. And he praised banks for reducing their leveraged lending exposure after regulators issued guidance in this area in 2013.
"Although we continued to find material weaknesses in the months that followed, the 2015 [Shared National Credit] review found lower levels of leverage and improved repayment capacity in bank leveraged loan portfolios," Curry said. "It seems clear that our guidance and follow-up helped mitigate the build-up of excessive risk in this market."
Though there have been improvements in credit quality since the financial crisis, Curry said his emphasis on the issue now has more to do with the traditional credit cycle than any current indicator or event.
"The direction we have charted at the OCC involves laying out high expectations in a transparent way and holding ourselves, as well as the banks we supervise, accountable for meeting those standards," Curry said. "I can't promise you that we'll never again face a serious financial crisis. But the 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."
Curry also gave an update on the OCC's efforts to monitor compliance of the large banks with the so-called "heightened standards" the agency set out for governance and risk management at large banks last year.
"This is expected to be an ongoing process so we have been examining our institutions for compliance to the specific provisions of the heightened standards that again, is tailored to the individual institution," Curry said. "There are areas that we've identified in previous examination activity that requires banks to address" including through "matters requiring attention, or MRAs, and also the [OCC's] ability to use the compliance plan mechanisms of the heightened standards."
When asked how satisfied the OCC was in banks' compliance, Curry replied, "there's been definite progress."
"Certainly in the banks' attention and recognition of the importance of a strong risk management system and strong governance," he said. "And that's really the heart of the heightened standards."