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As Banking Industry Improves, Risk Increases

As the United States economy continues to improve, the challenges facing the banking industry gradually shift from recovery to risk management in an effort to avoid the pitfalls that contributed to the financial crisis. In that spirit, the Office of the Comptroller of Currency released its Semiannual Risk Perspective of Spring 2014, offering an overview on the current health of the market and highlighting the significant risk related challenges that currently face the banking industry.

The report emphasized that 2013 was a year of steady improvement in the banking industry overall as net income was at an all-time high, approaching $108 billion and eclipsing the record that was established in 2006 before the collapse. However, the uptick in earnings still comes chiefly from lower non-interest and provision expenses instead of organic growth.

Revenue declined modestly as lower net interest income more than offset modestly higher non-interest income. Lackluster growth in loans issued and persistent low interest rates continue to depress net interest margins.

The report found that a decline in new foreclosure activity helped to offset declining origination activity in 2013.  New foreclosure starts are down in the prime and subprime segments, indicating a slow but widening housing market stabilization.

The percentage of seriously delinquent mortgages declined to 3.5 percent from 4.4 percent a year earlier. Foreclosures in process declined 37 percent from 3.3 percent of loans outstanding in the fourth quarter of 2012 to 2.1 percent in the fourth quarter of 2013.

Originations started out strong in 2013, but rising interest rates beginning in May caused activity to slow in the second half of the year. Demand for mortgages remains low as gains in job and income growth continue to be slow.

Because of the lack of organic growth, many banks are reevaluating their business models, deployment of capital, and risk appetites in the challenging operating environment. Some banks are taking on additional risks by expanding into higher-risk products.

The competition is becoming more intense, resulting in eased underwriting across a variety of financial products. In short, the banks are fighting tooth and nail for business and are increasingly willing to take-on riskier endeavors to push revenue.

The OCC warned that Banks' boards of directors and senior managers should monitor heightened exceptions to traditional underwriting standards and be aware of the product terms that produce additional risks. Compliance programs should keep pace with the volume and complexity of regulatory changes and changes in bank customers and transactions. Business lines within banks should perform thorough risk self-assessments and identify, assess, monitor, and mitigate emerging risks.

About Author: Derek Templeton

Derek Templeton is an attorney based in Dallas, Texas. He practices in the areas of real estate, financial services, and general corporate transactional law. His experience includes time as an Attorney Adviser for the U.S. Small Business Administration and as General Counsel for a nonprofit organization in Dallas. A self-avowed "policy junkie," he has a keen interest in the effect that evolving federal policy has on the mortgage, default servicing, and greater housing industries.

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