Darrin Benhart, Deputy
Comptroller for Credit
and Market Risk, Office of Comptroller of the Currency (OCC) said in
a speech on Wednesday that the banking industry has a good deal of data to be optimistic
about. But, he told the Mortgage Bankers Association's
Risk Management and Quality Assurance Forum his purpose was not to talk about
opportunities but rather about risk.
Despite the progress we've
seen, he said, the overall forecast
for the banking industry reflects slow growth in revenue and core profits. Low
interest rates, narrow
loan demand, and lower fee
income hinder stronger revenue
gains and historically low
short-term interest rates
continue to squeeze net interest margins.
The recent uptick in longer-term rates has heightened concerns about
increasing interest-rate risk and has
significantly slowed the mortgage refinance market.
OCC highlighted three key risk
themes in its most recent
Semiannual Risk Perspective that banks should understand and seek to mitigate. First,
strategic risk continues to increase as bank management searches for ways to generate acceptable returns,
often looking to new products and services that can
present unfamiliar risks they are not prepared to manage. Specific to
industry, more players, especially some community banks,
are entering the mortgage origination business to generate loan volume and more
fee revenue and banks are
strategically reducing or eliminating servicing in response
to heightened compliance expectations
and earning considerations.
Second there are challenges that arise in a period of sustained but slow growth
as many banks and investors begin to
"chase" yield, often
taking on more interest rate or credit risk
to maximize return. We are
beginning to see signs of the classic cyclicality in banking
where traditional lagging
indicators are improving so bankers start
to layer risk back into the system, he said.
One example is that the rate for jumbo mortgages, a traditionally
riskier product, recently dipped below that of conforming mortgages.
Third is the area of operational risks and those growing
in the system today are increasingly sophisticated
cyber threats, expanding dependence on technology, and
changing regulatory requirements. As some of the failures that caused the focus
operational risk came from the mortgage industry he told the group, that may
have given their industry a leg up in appreciating operational risk over other lines of business.
He said the new mortgage regulations have risk management
implications. The list of mortgage
related reforms is extensive, ranging from
updates to Regulation Z, Regulation X, compensation parameters, appraiser independence, to two of
the most significant reforms, Qualified Mortgage (QM) and servicing standards. An additional rule, the Qualified Residential Mortgage (QRM), is still being revised and reformulated.
He told the
audience that in planning for reforms they will need an even greater emphasis
on risk management techniques that not only look at credit
risk but also encompass operational and compliance
risk. A key part of
planning needs to include
the build-out of a strong
risk management function to ensure
compliance with the new rules.
the past, credit risk, operational
risk, compliance, audit, and quality control functions sometimes
worked in silos. As
a result, the systemic nature of problems across different products,
platforms, or risk areas often went unnoticed until the issue
was significant. Risk management groups today need to be multi-dimensional, and
banks need a culture
that promotes risk
identification across business lines. Complying with
the new rules doesn't negate the need for having other safety and soundness controls in place. For example the QM standard
establishes an ability-to-repay safe
harbor, but it does not address other
relevant underwriting criteria such as loan-to-value (LTV) or
credit history, key drivers of long-term loan performance.
The recently re-proposed
rule about QRM has some very significant changes as
a result of the thousands of comments
regulators received, most importantly the
alignment of QRM with
the CFPB's QM. This
so-called QM-plus approach, uses the core QM criteria
to define QRM but requires lenders
to evaluate three more aspects of the loan's underwriting; the first-lien status of a borrower's principal dwelling, a 70-percent LTV and assessment
borrower's credit history.
In other areas, the unprecedented runoff
in residential mortgages is moderating, Benhart said. The
contraction of residential mortgage credit had extended
from the second quarter of 2008 through
of 2012, and the total volume is down 12 percent since peaking
at over $11 trillion at
the end of March 2008.
This contraction was driven both by
purposeful reduction of household debt through payoffs and, more significantly,
through elevated defaults. These effects
far outweigh any increase in new mortgage demand. Although
existing home sales have shown recent growth,
these sales often result
in a transfer of debt,
rather than new growth.
Mortgage originations have improved13
since the financial crisis but have begun to slow as mortgage rates ticked up;
applications for refinancing have dropped 62 percent since May and applications for loans to purchase a home have fallen 16 percent.
As regulators, Benhart said, we focus not only on trends in originations but also on the performance of existing
loans and in recent years this has
served more as an anchor than an engine of growth. This however appears to be turning around.
Last year the housing market showed
increased investor demand and decreasing inventories. New home supplies are at 50 year lows and
many market are back in balance as the overhang of distressed mortgages
National Index shows home prices up over 10 percent year-over-year through June 2013 although prices remain well below the 2006
peak, and distressed sales continued
to account for a
large percent of sales. Home
price appreciation in some large cities is increasing at a pace that is
not consistent with other economic indicators.
This raises potential questions about its sustainability, a factor 0CC will be monitoring.
There has been steady improvement in the performance of mortgages serviced by the banks
and savings associations and OCC's numbers for the end of the first quarter of this year showed
slightly more than 90 percent of mortgages were current and performing, the highest percentage
since the third quarter of 2008.
Seriously delinquent mortgages also fell
to 4.0 percent of the overall portfolio, the lowest level in five years, but the more
than 900,000 loans in the
process of foreclosure remain a significant risk to the housing
recovery, especially in judicial
The performance of
junior liens is another concern.
Delinquencies here have remained relatively steady however they may soon
move sharply upward as a significant number of HELOC loans reach the end of
their draw period and monthly payment requirements will increase as amortization
HELOC - End of Draw:
Benhart pointed out
other areas on which OCC plans to focus in the coming year. He said they have done extensive work in the
largest institutions to assess the HELOC risk mentioned earlier and these
institutions are in varying stages of responding to the risk. OCC has stressed that banks offering HELOC
products should establish processes to quantify and
address this risk of increased
delinquencies and losses.
Collateral valuation is also a
concern. The industry has focused over
the last several years on modifications, foreclosures and servicing issues and
appraisals and valuations didn't get much attention. OCC competed reviews of a number of
institutions and found week governances of these programs. Concerns ranged from those about the
qualifications of responsible personnel to a lack of audit or internal control
functions. OCC found oversight lacking
for appraisal management companies and shortcomings in the development, reporting,
and review of evaluations. Prepackaged products, some of
which claimed to be
"guidelines compliant," lacked
even the basics-no opinion of "market
value," unsigned and
undated reports, even generic assumptions about
the actual physical condition of the
Lastly, OCC found deficiencies
in the review process for both appraisals
ranged from independence, qualifications,
and training of
reviewers to the scope and depth of
Benhart said in
summary, the condition of mortgage lending is a mixed bag: improvements
in first-lien performance, some growth on the horizon, but significant headwinds
from growing risk associated
with junior liens, elevated
delinquencies and higher interest rates.