May 13 - The Office of the Comptroller of the Currency recently reported that the financial condition of community national banks and federal savings associations (collectively, banks) in its nine-state Central District improved in 2013 as banks focused on strengthening risk management systems to help boost their performance.
More than 85 percent of 491 community national banks and thrifts located in the OCC’s Central District are top-rated, 1 or 2, on the five-point scale, a level not seen since early 2009. The OCC also reported that the number of problem banks fell to 72 institutions in the Central District, down from a peak of 146 national banks and thrifts in 2011.
“The renewed emphasis by OCC-supervised institutions on their people, policies and processes has quite clearly contributed to these encouraging trends,” said OCC District Deputy Comptroller Bert Otto. “The challenging economic conditions of the last several years highlighted the need for bankers to reconsider certain strategies and positions. As they’ve tackled these challenges, they’ve positioned themselves nicely to begin to capitalize on returning loan demand. I expect we’ll see some of that loan growth provide a further earnings boost in 2014.” Total loan growth across the district was 4 percent in 2013.
Throughout the Central District, the focus by banks on risk controls resulted in less examiner criticism and meaningful improvement in examination ratings. For instance, in Ohio more than 92 percent of banks had a composite rating of 1 or 2, up from 78 percent in 2009. In Wisconsin, the number of problem banks declined by half since 2010, the recent peak.
The pace of improvement in 2013 was most noteworthy in Chicago and Minneapolis, which saw the greatest decline in problem banks because of lower non-performing loan levels, reduced charge-offs, improving profitability and strengthened capital.
“Community banks and thrifts supervised by our Chicago team had been in survival mode for several years,” noted Nathan Perry, Assistant Deputy Comptroller. “The level of problem banks has declined as risk management practices improved. Additionally, improvements in the real estate market and overall economic conditions have helped banks to work out of problem assets.”
The recovery for Minnesota institutions came sooner. While the number of problem banks peaked in 2010, the number has fallen by 70 percent since that time for those supervised by the OCC’s four local Minneapolis area examination teams. “Many OCC-supervised institutions recognized six to seven years ago that concentration levels had become excessive,” said Thomas Tott, Assistant Deputy Comptroller in Minneapolis. “Most made difficult decisions to shore up weaker borrowing relationships and shed non-strategic customers. Those actions helped speed the recovery in Minnesota.”
Operational risk management encompasses the administration of a bank’s people, policies, processes and systems, including information security and technology management. “Despite the strides evident in improved governance, we are noting some aspects of operational risk which warrant increased vigilance. This is particularly true in the area of cybersecurity; where, as these risks continue to evolve, we expect institutions to have a robust process to identify and mitigate the threats,” said OCC Risk Committee Chairman and District Risk Officer John Meade.
The OCC’s Central District supervises 491 banks, ranging in asset size from $3.3 million to $11.3 billion. Combined, these banks hold $191 billion in assets. The OCC’s Central District covers all or parts of nine states including Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, North Dakota, Ohio and Wisconsin.
Key points from the briefing:
o More than 85 percent of banks located in the nine states in the OCC’s Central District are rated 1 or 2 on the five-point CAMELS scale with one being the best performing, a level not seen since early 2009. The CAMELS rating system consists of a bank’s Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk.
o Problem banks in the Central District fell to 72 in 2013, down from 106 in 2012 and 146 in 2011.
· Nearly two-thirds of the Central District’s problem banks are concentrated in Illinois, Minnesota, and Wisconsin.
· Positive trends in problem bank levels were most pronounced in OCC banks and thrifts in Chicago and Minneapolis.
· Banks in Kentucky and Ohio were strongest at year-end 2013 with less than one in 10 identified as a problem bank, the strongest level since the end of the financial crisis.
Lending picked up in 2013 after several years of flat to declining volumes.
· With the health of institutions improving, certain district-supervised banks are enjoying increased credit originations.
· Aggregate district loan growth totaled 4 percent in 2013.
· OCC-supervised banks and thrifts in Indianapolis, Minneapolis, central Illinois, and throughout Ohio are experiencing higher growth rates. Drivers of the growth are centered in commercial and industrial, owner-occupied commercial real estate, and multifamily real estate lending.
· The economic recovery has not been as robust in areas like Chicago where loan growth has proven elusive.
· Agricultural lending is a key component of many district bank portfolios. As of Dec. 31, 2013, nearly one in four of OCC-regulated banks had agricultural loan exposures exceeding 100 percent of capital. Risks are generally managed appropriately, which alleviates some concern with the relatively high concentrations.
Regulators see positive trends in financial performance, but banks may be challenged to further improve profitability in the near term.
· Earnings at Central District supervised banks were flat from 2012 to 2013, after several years of improvement.
o Income measures were flat for return on assets and return on equity at 0.62 percent and 6.5 percent, respectively.
o Reduced provision for loan loss expenses offset reductions in the net interest margin. Loan charge-offs and provision expenses have fallen to very low levels, and limited future benefit to earnings from this source is foreseen.
· Sustained improvement in earnings may prove to be difficult.
o Nearly half of Central District-supervised banks saw a net interest margin decline of at least 20 basis points.
o Fewer than one-sixth of the banks realized a net interest margin lift of 10 basis points or more.
o Avenues to boost revenues have largely been tenuous without accepting higher levels of credit or interest rate risk (IRR).
· Capitalization ratios improved modestly in 2013 as a result of earnings retention and moderating asset growth.
Top risks facing community banks and thrifts in the Central District
· Strategic risk remains high with vulnerabilities in the continued low interest rate environment, coupled with the modest economic recovery. These factors have constrained opportunities for profit growth. Among Central District banks, nearly 70 percent face moderate or high strategic risk, up from 60 percent two years ago.
· Credit risk management is of heightened concern, particularly in commercial lending. A desire to diversify away from commercial real estate loans, which did not perform as well during the downturn, contributed to a pronounced 2013 increase of 10 percent in commercial loan volume. The rate of growth may prove difficult to sustain, as the pace of economic growth in the district is not as rapid. Further, the OCC has noted some relaxation of underwriting terms and structure, including aggressive pricing. In 2013, credit risk management weaknesses identified as Matters Requiring Attention (MRA) continued to constitute nearly half of the primary concerns noted in examinations.
· IRR is elevated with risk building in investment portfolios. Interest rate volatility in mid-2013 contributed to significant swings in portfolio values. Institutions invested in longer term investments may be susceptible to future rate increases. In these banks, IRR is increasing and in some cases management is not monitoring and managing this risk appropriately.
· Compliance and reputation risks continue to rise, with nearly two-thirds of district banks assessed with either moderate or high compliance risk.
· Operational risk concerns have emerged in district banks, particularly in the areas of enterprise governance and risk management systems. As revenue growth challenges persist, more banks are scrutinizing expense budgets to determine where cuts can be made. Nearly three-fourths of district supervised banks have been assessed as having moderate or high operational risk, and MRA volumes are escalating in the areas of management supervision and planning, information technology, and audit program oversight.