Banking Regulator Sounds Warning on Rising Credit Risk

All Banking Law, All in One Place. Bloomberg Law: Banking is the comprehensive research solution that powers your practice with access to integrated banking-related legal news, analysis,...

By Jeff Bater

Oct. 21 — A federal regulator told banks and supervisors to step up their vigilance over credit risk, calling attention to growing exposures in commercial real estate loans and warning about subprime automobile lending.

Comptroller of the Currency Thomas Curry, in remarks to the Exchequer Club in Washington, said that after several years of steady loan growth, banks are reaching out to less creditworthy borrowers.

“We are clearly reaching the point in the cycle where credit risk is moving to the forefront,” he said.

Historically, following a period of economic recovery, banks relax loan underwriting standards and develop larger loan concentrations without concurrent increases in reserves.

Need for Vigilance 

“It's a natural byproduct of competition during the later stages of the economic cycle, and so it’s a time when supervisors and bank risk officers need to be most vigilant,” Curry said.

In December, a survey by the Office of the Comptroller of the Currency (OCC) revealed competition, abundant liquidity and reaching for yield have caused banks to continue easing underwriting standards, with findings that parallel those revealed not long before the 2008 financial crisis. In his speech, Curry said that examiner reports also document rising credit risk among banks.

“We are not yet seeing a uniform or comprehensive industry response to these early warning signs,” he said, while quickly adding, “We are encouraged, however, by those institutions that are building loan loss reserves or, in some cases, reducing credit risk by avoiding or reducing their exposure to higher risk loan products.”

Strength Can Be Misleading 

Curry said it is easy to ignore credit risk when asset quality is strong and lending is profitable. Commercial and industrial loans have increased for 18 straight quarters, he said, and loan growth at community banks has been particularly strong. “These facts are impressive,” Curry said. “But they can also be a misleading indicator of the fundamental health of the banking system. Credit quality, after all, reflects the outcome of decisions made when loans are originated, perhaps months or years earlier, possibly under tougher standards than those in effect today.”

The OCC has seen “noteworthy improvements” in risk management involving leveraged lending and home equity lines of credit (HELOC), according to Curry. He called on regulators to remain vigilant about automobile lending.

Auto Lending Concerns 

Banks supply “a significant amount” of the financing that propels car sales, and at the end of the second quarter of 2015, auto lending represented more than 10 percent of retail credit in OCC-regulated institutions, up from 7 percent in the second quarter of 2011, Curry said. Increasingly, banks are packaging those loans into asset-backed securities instead of holding the loans in a portfolio.

“These securities are being greeted by strong demand from investors, who no doubt remember that securities backed by auto loans outperformed most other classes of asset-back securities during the financial crisis,” he said. “But what is happening in this space today reminds me of what happened in mortgage-backed securities in the run up to the crisis.

“At that time, lenders fed investor demand for more loans by relaxing underwriting standards and extending maturities,” Curry said. “Today, 30 percent of all new vehicle financing features maturities of more than six years, and it’s entirely possible to obtain a car loan even with very low credit scores.”

Watching Real Estate Exposures 

With those longer terms, borrowers remain in a negative equity position much longer, exposing lenders and investors to higher potential losses, Curry pointed out. “Although delinquency and losses are currently low, it doesn’t require great foresight to see that this may not last. How these auto loans, and especially the non-prime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry.”

A top OCC official talked about risks in auto lending during a speech about a year ago. Darrin Benhart, deputy comptroller for supervision risk management for the agency, said competition was one of the factors behind the increased risk, with some lenders lengthening terms, increasing advance rates, and originating loans to borrowers with lower credit scores.

While neither auto loans nor home equity loans are inherently unsafe, Curry said, excessive concentrations of any one kind of loan are unsafe. “You don’t need a very long memory to recall the central role that concentrations — whether in residential real estate, agricultural land, or oil and gas production — have played in individual bank failures and systemic breakdowns,” he said.

“It’s an old movie that’s been reprised on a regular basis. That’s why we’re closely watching growing exposures in commercial real estate loans, especially in the construction and multifamily housing sectors, as well as in loans to non-depository financial institutions,” he said.

To contact the reporter on this story: Jeff Bater in Washington at

To contact the editor responsible for this story: Seth Stern at

Curry's remarks are available at