ALLL Methodology

By: Ken Bennett, CPA

The Office of the Comptroller of the Currency (OCC) recently released two detailed publications regarding a Survey of Credit Underwriting Practices for 2016 and a Semiannual Risk Perspective from the National Risk Committee.  The Federal Reserve also recently released a new edition of The Beige Book.  These publications offer insight regarding the credit cycle, underwriting, regulatory compliance challenges, concentration management, interest rate risk, operational risks, cyber threats, and other topics.  For Steve H. Powell & Company updates regarding regulatory compliance issues, please subscribe to our Compliance Pipeline. 
 
Primary findings of the Survey of Credit Underwriting Practices note generally acceptable, but loosening, underwriting standards that are consistent with previous credit cycles:

• Banks continue to ease underwriting practices in response to competitive pressures, expanding credit risk appetites, and a desire for loan growth.
• While overall underwriting practices remain satisfactory, an increasing tolerance for looser underwriting has resulted in continued movement from more conservative underwriting practices to more moderate underwriting practices, a trend consistent with past credit cycles.
• Credit risk has increased since the 2015 survey in commercial and retail lending activities, and examiners expect the levels of credit risk in these areas to increase over the next 12 months. Primary areas of concern are aggressive growth rates, weaknesses in concentration risk management, deterioration in energy related portfolios, and the continued general easing of underwriting practices.

 
The Semiannual Risk Perspective (regarding the first half of 2016) noted increased revenue but decreased net income due to an increase in provision expenses.  The publication also notes stronger return on equity (ROE) in banks with assets of less than $10 billion as compared to banks with assets of more than $10 billion.  The report details:

• Strategic planning remains important as banks adopt 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 (fintech firms).·        
• Continued incremental easing in underwriting standards is a concern as banks strive to achieve loan growth and to maintain or grow market share. Easing of underwriting standards in commercial, CRE, and auto lending presents increasing credit risk.
• Rapid CRE loan growth over the past year and recent underwriting reviews raise concern over the quality of CRE risk management, particularly managing concentrations.
• Operational risk remains a concern as banks deal with changing cyber security threats, increased reliance on third-party relationships, and address the need for sound governance over sales practices.
• Some banks continue to face challenges in complying with Bank Secrecy Act (BSA) requirements as money laundering and terrorism financing methods evolve.
• Change management processes are posing a challenge as banks allocate resources to implement processes and controls for multiple new or amended regulations including the integrated mortgage disclosures under the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act
• (RESPA) and the new requirements under the amended regulation implementing the Military Lending Act (MLA).

 
 
Also, in additional detail, the publication discusses a mixed commercial real estate (CRE) outlook, potentially subdued GDP growth, expectations of farm income continuing to decline (in 2016 – per USDA projections), stable but historically low net income margins, segments leading commercial loan growth, and increasing loss severity in auto lending.