The FDIC recent released its Winter 2016 edition of Supervisory Insights. This edition was focused on credit risk trends.
The report indicated that loan growth is strong among commercial banks with 80% of institutions’ loan portfolios increasing in the last quarter of 2016. This is close to the 2005 peak when 83% of institutions grew their portfolios. The data suggest that the rate of loan growth is approaching the pre-recession peak.
This edition focused on (3) sectors that have proved both volatile and problematic for institutions in terms of asset quality: commercial real estate, agriculture, and oil and gas. The report suggests concentrations have increased in commercial real estate and agriculture.
Although oil and gas is not directly measurable in Call Report data, markets in which oil and gas are key sectors of the economy suggest that concentrations have increased in that sector as well.
The FDIC seemed to strike an optimistic but cautious tone in regard to asset quality. They cited growing concentrations; and while they stressed these were not necessarily problematic, they emphasized the need for effective management including loan loss reserves and liquidity in addition to monitoring.
Economic Conditions
This edition indicated that demand continues to grow for commercial real estate with vacancy rates generally declining. The only exception noted was with respect to multi-family in which there was a slight increase in vacancies. Since occupancy is critical to the viability of CRE as well as values, this is something that should be watched closely.
With respect to the agriculture segment, farm income has declined in the last two years and the USDA has indicated this will continue. Commodity prices have been and remain under considerable pressure, which will continue to affect the industry.
Oil and gas continues to be volatile, with oil fluctuating from $100 plus a barrel to less than $40 a barrel in the last two years. Although this is one of the hardest sectors to predict, it will likely continue to be volatile in the short term.
Best Practices with Respect to Asset Quality
The fundamentals to manage the risk associated with these types of credit are fairly simple — the challenge comes with effective and consistent execution. Some keys noted that require attention for effective management and that are expectations in terms of safety and soundness examinations:
- Internal controls and auditing
- Documentation
- Prudent underwriting
- Portfolio diversification
- Interest rate risk
- Asset growth and concentrations
- Board and management oversight
- Market analysis of economic conditions
Practices to be Avoided
Some issues that can weaken asset quality standards and should be avoided are as follows:
- Absence of limits on concentrations
- Inadequate monitoring or reporting of concentrations
- Many exceptions to loan policy
- Unsupported cash flow projections
- Lack of global cash flow analysis
- Excessive cash-outs and interest only terms
- Insufficient internal loan review
- Weak appraisal programs
- Failure to stratify concentrations within key segments (such as CRE)
- Poor construction and development lending oversight
The full report can be found here:
https://www.fdic.gov/regulations/examinations/supervisory/insights/siwin16/si_winter_16.pdf