In the most recent edition of its semiannual risk report, the Office of the Comptroller of the Currency identified several key areas of risk priorities for various national lender markets. While the overall financial performance of lenders improved throughout 2015, the OCC pointed to persistent risk requiring ongoing supervision, particularly among community, small- and mid-sized banks.
"It's at this stage of the cycle that we also see strong loan growth combined with easing underwriting to result in increased credit risk," Comptroller of the Currency Thomas Curry said upon the release of the report. This loan growth has been driven by the aforementioned eased lending standards, as well as lower U.S. Federal Reserve interest rates, leading to intense competition amongst lenders. While this has helped bolster the global economy and further distance markets from the lows of the global financial crisis, eased underwriting has led to a surge in risk that the OCC urges must be watched carefully.
Auto lending
The agency particularly flagged what it called a "notable and unprecedented growth" in automotive lending. Total auto loan volumes have grown 50 percent in the last five years, with delinquencies rising as well.
"Total auto loan volumes had grown 50 percent in the last five years."
"As banks have competed for market share, some banks have responded with less stringent underwriting standards," the report stated. The issue with auto lending growth is that collateral values have been on a steady decline, leading the OCC to conclude that "some banks' risk management practices have not kept pace with the growth and increasing risk in these portfolios."
This seems to agree with previous statements made by Curry before gathered members of the Exchequer Club in October of 2015, warning that, in spite of strong demand creating the appearance of a healthy auto lending market, recent activity "reminds me of what happened in mortgage-backed securities in the run-up to the crisis."
Commercial real estate
In addition to auto lending, Curry and the OCC pointed to weaknesses in commercial real estate lending that could signal the emergence of a new real estate bubble. CRE loans, according to a Morgan Stanley report quoted by the Financial Times, jumped 44 percent in the first quarter of 2016 from the same period in 2015. Leading the charge in lending were smaller banks, which more than doubled their CRE portfolios over the last three years.
"Retail centers were seen as areas where the weaker underwriting could prove hazardous."
"While leveraged lending and auto lending remain concerns, CRE lending and concentration risk management has become an area of emphasis for regulators," Curry said in a speech. "Our exams found looser underwriting standards with less-restrictive covenants, extended maturities, longer interest-only periods, limited guarantor requirements, and deficient-stress testing practices."
Shopping malls and larger retail centers were seen as areas where the weaker underwriting could prove potentially hazardous.
"We are already seeing increased defaults on loans secured by shopping malls," the Morgan Stanley report noted, "which is a trend we expect to continue."
Hope via innovation
While the outlook in some areas is tentative, the OCC does point out that strategic risk for smaller and midsize banks is rising in a way that may be healthy. The agency urges lenders to focus on keeping up with innovative new loan products and deploy credit analytics to reinforce existing underwriting standards.
"Banks are increasingly adopting innovative products, services, and processes in response to the evolving demands for financial services and the entrance of new competitors, such as out-of-market banks and financial technology firms," the agency said. Indeed, as smaller, more nimble lenders have begun offering competitive, innovative products, their returns have proven healthier than those of their larger peers. The report notes that banks with less than $1 billion in assets delivered return on equity over 10 percent in 2015, outpacing larger banks.
