OFR Report Sees Weak Standards for Loan Underwriting

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By Jeff Bater

Jan. 27 — A Treasury Department unit warned banks about weak underwriting standards and exposure to oil prices in a report to Congress analyzing threats to U.S. financial stability.

The Office of Financial Research (OFR) also suggested that data on cybersecurity incidents may be insufficient and that regulators could take the step of requiring financial firms to report details on breaches or risks.

The OFR's call on loan criteria echoes previous warnings by regulators against banks reaching for yield in the current low-interest rate environment (204 BBD, 10/22/15).

Regulatory review of large syndicated loans has detected a significant increase in leveraged lending volumes — as well as finding that falling energy prices have the potential to hurt the performance of loans to oil and gas explorers and producers (227 BBD, 11/25/15).

In 2013, regulators, seeing an increase in leveraged lending since the crisis, put out an updated 12-year-old guidance that focuses on risk management and underwriting standards (56 BBD, 3/22/13). The Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency released guidance that covers transactions characterized by a borrower with a degree of financial leverage that significantly exceeds industry norms.

In its new report, the OFR said some U.S. corporations have tried to maintain their earnings growth by cutting costs. Other firms, instead of using loan proceeds to pay off their debt, are increasing debt through acquisitions, leveraged buyouts, dividend payments to shareholders and buying back their stock.

Regionals at Risk

“Joint action by federal financial regulators in 2013 and 2014 has helped to reduce the number of bad loans and to curtail banks from issuing leveraged loans,” the OFR said in its annual report to Congress. “Despite that progress, standards for loan underwriting remain weak.”

The drop in oil prices and slowdown in global economic growth have diminished the ability of multinational corporations to repay debts. The OFR said regional banks with exposures to energy companies or to local economies dependent on the energy industry face the prospect of increases in troubled loans. “Many of them have already increased their loan-loss reserves in response, but the ultimate magnitude of losses in these industries and regions is uncertain,” the report said.

Cybersecurity Issues

The research office was created by the Dodd-Frank Act to support the Financial Stability Oversight Council and measure risks to the financial system. A risk that regulators have been increasingly flagging in recent years involves cyberattacks. In the report, the OFR acknowledged efforts by government and industry in response to attacks but also said regulators need to coordinate to collect data assessing the impact of attacks on the U.S. financial system.

“Current information on the frequency and concentration of cybersecurity incidents in the financial sector may be inadequate to detect trends and determine investment priorities,” the OFR report said. “Although financial companies may be reluctant to disclose cybersecurity breaches because of concerns about undermining their reputations, U.S. regulators could require the firms they supervise to monitor and report details about the cost and frequency of cybersecurity breaches or risks in the financial system.”

To contact the reporter on this story: Jeff Bater in Washington at jbater@bna.com

To contact the editor responsible for this story: Mike Ferullo in Washington at mferullo@bna.com

For More Information 
The report can be found at http://src.bna.com/ce5.