5 Current and Future Credit Risk Trends at Community Banks: Problem Loans Have Declined-But Anxiety over Credit Quality Is Building

By Camerini, Giulio; Miller, Scott | ABA Banking Journal, March-April 2017 | Go to article overview

5 Current and Future Credit Risk Trends at Community Banks: Problem Loans Have Declined-But Anxiety over Credit Quality Is Building


Camerini, Giulio, Miller, Scott, ABA Banking Journal


According to the Office of the Comptroller of the Currency, credit risk continues to be the root of the most matters requiring attention issued by federal banking regulators, ranking as the top type of MRA at community banks for most of the previous 12 months. The mounting credit risk--along with the increased cost of compliance, low interest rate environment and general uncertainties--has made for anxious bankers. Five credit risk trends in particular warrant attention from community banks.

The Easing of Underwriting Standards

Loosened underwriting standards have been the dominant trend for some time, as reflected in semiannual OCC Sports. The intense competition for loans is pushing some banks to ease their standards for high-growth loan products. Such action can seem near-mandatory in the changing lending arena. Educated loan shoppers have countless avenues to pursue favorable rates and niche offerings, with marketplace lenders and nonbank fintech firms rapidly picking up steam.

To make matters worse, the days of institutional loyalty among borrowers are fading fast.

Real estate developers long have devalued relationships with institutions and newer-generation borrowers are following their lead in traditionally relationship-based areas of lending. Middle-market, small business and agricultural borrowers often value products, convenience and terms over a history of working with a single institution.

But savvy banks have begun to selectively tighten their underwriting on certain products, including oil and gas loans and multifamily loans. They also are trying to put data to work to identify early indicators that could help mitigate risk. Banks with strong data reporting on their loan portfolios can uncover the areas of greater risk and adjust accordingly. For example, community banks might compile data on default and waiver trends, track financial covenant defaults, or track an increase in loan grade deterioration.

Banks continue to seek ways to improve efficiency as well. Although essential in a low-rate and high-regulatory-cost environment, banks can find it a challenge to boost efficiency without compromising credit quality or exceeding their risk appetite. Most banks already have made adjustments to staffing, branches and vendor relationships to offset low rates. If rates rise, though, some of the resulting efficiencies could temporarily disappear in the lag before loan volumes catch up.

2 Portfolio Composition

Community banks are facing several risk issues related to their loan portfolios, including growing concerns related td commercial real estate loan concentrations, certain stressed commodities and new products.

In 2006, the federal banking agencies issued guidance on sound risk management for banks with high and increasing concentrations of ORE loans on their balance sheets. The regulators issued a new joint statement in December 2015 to reinforce the importance of prudent risk management practices for CRE lending.

The latest statement stems from the substantial growth the agencies have observed in many CRE asset and lending markets and, in turn, rising CRE concentrations in banks. The statement also notes certain risk management practices that have caused concern, including a greater number of underwriting policy exceptions and insufficient monitoring of market conditions to assess the risks associated with these concentrations.

Meanwhile, certain commodities are experiencing problems that have resulted in higher reserves for loans involving those commodities. For example, oil and gas prices have been depressed for about 18 months, causing strains for banks that lend directly to oil and gas companies, oilfield services firms and to oil patch communities. Similarly, the agriculture industry--particularly the grain sector--has seen prices fall after posting record levels only three years earlier. …

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