The Office of Comptroller of the Currency's (OCC) National Risk Committee (NRC) pronounced the financial position of federally chartered institutions "improved" last year in its Semiannual Risk Perspective issued on Wednesday.  The federal banking system set a new record level of net income that was only $5 billion or 5 percent higher than the previous pre-financial crisis record set in 2006 and it took seven years and $1.5 trillion or a 20 percent growth in assets to achieve it.  This, the report said, highlights the slow pace of the recovery.

The Perspective presents data in five main areas: the operating environment; the condition and performance of the banking system; key risk issues; elevated risk metrics; and regulatory actions.  It focuses on issues that pose threats to the safety and soundness of banks rather than opportunities that banks may encounter at the same time. The report reflects data as of December 31, 2013.

While conditions overall showed improvement in the second half of 2013, the OCC reports that credit risk is building in supervised national banks and federal savings associations following a period of improving credit quality and problem loan clean-up. Competitive pressures, and strategic and operational risks top the list of supervisory concerns.  Essentially, the OCC is saying banks' efforts to make a profit in light of increased regulatory costs and low-volatility market conditions are risky.

Return on assets and on equity remain below their pre-recession peaks.  The federal system as a whole returned almost 10 percent on equity but small institutions are lagging behind large ones.  Revenue was down as lower net interest income more than offset slightly higher noninterest income and sluggish loan growth and low interest rates weigh on net interest margins.  Improvements in earnings are still coming more from lower noninterest and provisions expenses rather than real growth. In addition, banks continue to face competitive pressure from nonbank firms seeking to expand into traditional banking activities.

Intensifying competition for lending opportunities is causing banks to loosen underwriting standards especially in commercial loans, indirect auto, and leveraged lending.  Risk layering is also a concern in commercial loans.  While not widespread, some examiners have noted multiple policy and underwriting exceptions on individual credit decisions which OCC and Federal Reserve Board surveys of lending practices have confirmed.

The increase in long term interest rates in 2013 underscores the need to understand and quantify banks' vulnerability to rising interest rates.  Some banks have reached for yields to boost interest income with decreasing regard for interest rate or credit risk. For example, banks that extend asset maturities to increase yield could face significant earnings pressure, especially if relying on the stability of non-maturity deposit funding in a rising rate environment,

Slow economic growth is pushing banks to reevaluate business models, capital deployment, and risk appetites and some are on taking on additional risks by expanding into new, less familiar, or higher risk products.  OCC says its examiners will focus on strategic business and new product planning to monitor risk management processes.

Some banks are lowering overhead expenses, often by reductions in control functions, exiting less profitable businesses, closing offices, and outsourcing critical control functions to third parties, in some instances without appropriate levels of due diligence.

Cyber-threats continue to evolve, requiring heightened awareness and appropriate resources to identify and mitigate the associated risks.

Financial asset prices have experienced very low volatility for an extended period. As a result, measures of price risk, such as value-at-risk, are at very low levels. The reduced willingness of dealers to hold securities in inventory, due to capital and other concerns such as a change in monetary policy, could contribute to greater price swings going forward and increased price risk.

Bank Secrecy Act (BSA) and anti-money laundering (AML) risks remain serious concerns as money-laundering methods evolve and the volume and sophistication of electronic bank fraud increases.  These risks have grown among community banks during the last few years because of increases in the number of higher-risk, cash intensive customers and internationally oriented transactions.  BSA programs at some banks have failed to evolve or to incorporate appropriate controls into new products and services. 

The report makes only a few brief mentions of the residential loan sector, citing shrinking refinancing activity as a risk factor for smaller banks and that charge-offs of residential loans has decreased while delinquencies among HELOCs has increased.  The one section devoted to residential mortgages notes that the decline in new foreclosure activity has helped to offset slowing mortgage origination activity.  Foreclosure starts for both prime and subprime loans fell indicating that the market is stabilizing but also attributed in part to the improving economy and aggressive foreclosure prevention actions. 

Mortgage originations started out the year strong but rising interest rates caused activity to falter starting in May.  With improvements in job creation, income growth, and household formation lagging, demand for mortgages remains low.