Credit Risk Today: an OCC Perspective
Samantha: Hello, this is Samantha Shares.
This episode covers the O C C's
current thoughts on Credit Risk
This podcast is educational
and is not legal advice.
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Exam Solutions Incorporated, whose
team has over two hundred and forty
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Credit Risk: COMMERCIAL CREDIT THEMES
Commercial credit risk remains
moderate and shows signs of
stabilizing as risks are better
identified, monitored, and controlled.
Elevated but declining interest rates
could continue to affect borrowers
with loans that originated before 2022,
especially those with variable rates,
or borrowers seeking refinancing.
Credit risk drivers indicate
pockets of risk specific to a
lender's region and lending market.
The current operating environment remains
challenging, especially for companies with
higher leverage and marginal repayment
capacity, smaller and lower-rated firms
with near-term debt maturities, firms
with a higher level of floating debt, and
firms with limited financial flexibility.
It is important that banks continue
to use sound credit risk management
practices such as stress testing at
both the portfolio and facility levels,
timely and accurate risk ratings, and
effective concentration risk management.
The C R E office sector continues
to experience stress, and there may
be additional valuation declines and
bank losses as a volume of office and
multifamily loansâmany with interest-only
termsâare set to mature or reprice
over the next two to three years.
C R E borrowers seeking to refinance
may need to re-margin through cash
equity injections or by providing
additional collateral because of higher
debt costs and lower property values.
Generally, banks are appropriately
identifying problem office C R E loans,
and the O C C expects banks to continue to
have credit risk management systems that
produce accurate, timely risk ratings.
Classified loan levels may increase
but are expected to remain manageable.
Risks in multifamily C R
E lending remain elevated,
particularly in the luxury segment.
Nationwide, pressures from higher
interest rates and increased
expenses are slowing the growth
in net operating income (N O I).
Oversupply in some southern, southeastern,
and western metro areas and changes in
rent regulations in some markets have
resulted in further narrowing of N O I.
The hotel and industrial sectors
continue to show signs of softening.
While banks with C R E concentrations
continue to present heightened risk,
C R E loan growth has slowed overall.
Staffing continues to be
challenging in the loan workout
and credit risk review functions.
During the most recent benign
credit period, retirements and
other attrition decreased the
number of experienced professionals.
It remains important for banks to ensure
that experienced staffing is adequate.
The allowance for credit losses
(A C L) should continue to reflect
a forward-looking assessment
of loan portfolio risks.
This includes considerations for
potential loss drivers from a bank's
current business, economic, and
overall operating environments.
The A C L should include appropriate
adjustments, such as qualitative factors,
recalibration, or model redevelopment, to
address potential modeling imprecision.
RETAIL CREDIT THEMES
Retail credit performance
remains satisfactory, and overall
retail credit risk is stable.
In recent years, consumers benefitted
from strong employment and wage growth,
but those factors are beginning to slow.
However, the labor market's rebalancing
of supply and demand does not currently
indicate systemic consumer stress.
Consumer segments that are most
susceptible to elevated prices are highly
leveraged, lower income borrowers, but
do not present systemic credit risk.
Delinquency and loss rates on
residential real estate-secured
loans held by banks remain
historically low but are increasing.
Delinquencies in other retail asset
classes, namely credit cards and auto
loans, reflect an increasing trend.
However, banks' retail credit loan
performance is consistent with many
industry forecasts reflecting delinquency
and seasonal loss patterns normalizing
from atypical historically low levels.
Portfolio growth was generally
flat for the first half of 2024.
Headline nominal growth in credit card
outstandings continues, largely because
of several years of high inflation.
Credit risk drivers continue to
include higher interest rates on newly
originated loans with potentially
higher loan-to-value ratios,
upward adjustments on variable rate
loans, and borrower segments with
more limited repayment capacity.
Banks reported tighter lending standards
across most categories of residential
real estate lending, and with credit
card, auto, and other consumer loans
in response to economic uncertainty.
As risk profiles change, increased
portfolio monitoring may be
warranted with appropriate risk
allocation within the A C L.
Sound governance, transparency,
and documentation of assumptions
and judgments, including those for
scenario selection and weighting,
are critical to an appropriate A C L.
Homeowners face mortgage
payment increases.
Home price appreciation is contributing
to increased real estate taxes, and
insurance costs are increasing because
of appreciating home values, rising
construction costs, and insurability
issues related to climate-related events.
Affordability pressures in some
geographies are more material
and may adversely affect
borrowers' ability to repay debts.
The increase in housing obligations may
warrant enhanced risk identification,
monitoring, and reporting.
Despite increasing costs, the median
monthly payment increase in taxes and
insurance is not anticipated to have
a systemic impact on retail credit.
Collateral administration
policies should outline standards,
responsibilities, processes, and
internal controls so banks maintain
appropriate collateral protection.
Such policies and procedures should
facilitate timely identification,
remediation, and reporting of
expired insurance policies and
inadequate insurance coverage.
If your Credit union could use assistance
with your exam, reach out to Mark Treichel
on LinkedIn, or at mark Treichel dot com.
This is Samantha Shares and
we Thank you for listening.
