Early in December the OCC published their Annual Survey of Credit Underwriting Practices, which was based on the results gathered in their June survey of 95 banks and federal savings associations.  To no one's surprise, the survey confirmed the expected easing of underwriting standards that the OCC's Curry had forewarned about in speeches and publications throughout the fall.

The survey reflects observations by the OCC examiners in the field at supervised banks, and their assessment of changes occurring in those banks over the prior 12-month period.  Competitive pressures were cited as a leading factor in situations where banks were loosening their standards.  This was seen in relaxed terms and aggressive pricing, with 64% of banks having adjusted pricing to be competitive, according to the survey.1 The pressure was resulting in many undesirable outcomes from a risk management perspective, and the survey confirmed that an increased risk appetite exists in these banks.  Examiners reported increases in the frequency of exceptions being made to loan policies, although they point out that those exceptions are being adequately documented and appropriately approved.

The comparisons with the 2006 survey results are disheartening, as similar year-over-year increases in risk are a foreboding statistic, and the outside factors are also familiar ones, with competition, changing interest rate environment and economic conditions playing a role in both time periods.  The primary area of concern is again the real estate portfolio on the commercial side.  These portfolios are growing rapidly, and often supported by valuations that appear optimistic.  When the other factors such as more frequent policy exceptions and a potentially volatile interest rate environment for the life of the loan are considered, the risk level is even more of a concern.

The FDIC released a Financial Institution Letter on December 18^th, shortly after the survey results were circulated, which highlighted concerns the agencies are having with CRE lending.  This FIL focused on the loosening of standards in the underwriting of CRE loans, and emphasized the need for banks to remain disciplined in their practices with regard to this portfolio.2

While these are comments of a US regulator based on reviews of US institutions, the global industry is likely experiencing similar issues, and as we saw in the recent crisis, the industry ties across borders are strong.  Deterioration in one region is not easily contained due to the global economy we now enjoy.  The increased focus on avoiding another crisis is therefore not just a concern of the OCC and FDIC.  Also in December, the Basel Committee on Banking Supervision released a document titled "Revisions to the Standardized Approach for credit risk", which is open for comment until March 11, 2016.  This is the second consultative document, incorporating the responses received to the December 2014 original publication.  Their initial document stemmed largely from the criticisms around how external credit ratings were developed and handled, and this second document continues the effort to simplify this rating process while maintaining its merit.  Limitation on the use of automation in ratings is considered valuable, yet consistency across jurisdictions and markets is desired to avoid a repeat of the ratings debacle.3 The joint US agencies released a statement related to this paper which reminds US banks that the proposed revisions apply to internationally active institutions, however the issue further highlights the concern with the current direction of credit as being global subject.

It is anticipated that US regulators will soon be taking another step in risk management with an expected update to the stress testing that is part of the CCAR process.  The Fed has been reviewing the CCAR program since April, and that included gathering of input during meetings with bankers, analysts, etc., which in some cases were attended by Fed Gov. Daniel Tarullo.  While the primary objections from bankers regarding the stress tests have been related to the secrecy of how the tests are structured, the Fed continues to defend that process and assure concerned parties that the models are adequately tested and validated by appropriately skilled resources.  While ultimately the goal of stress testing is to assure the public that the capital levels of the banks will be adequate to allow for lending activity to continue even in a downward trending economy, the banks argue that the models may not be testing for those scenarios sufficiently, and if the result is that lending is curtailed it would indeed exacerbate a troubled economy, exactly what the CCAR process was designed to avoid.4

It ought to be of some comfort to acknowledge that the regulatory bodies are alert to these concerns at this point, but the sense of foreboding, that we are doomed regardless of these valiant efforts to repeat history, is strong.

3 https://www.bis.org/bcbs/publ/d347.htm