OCC survey highlights importance of risk ratings

Dec 10, 2015

Findings from a new survey of examiners with the Office of the Comptroller of the Currency (OCC) highlight the importance of credit risk rating systems. The OCC said its examiners are seeing increased credit risk as banks and federal savings associations have eased underwriting standards to pursue portfolio growth and yield.

In releasing its 2015 Survey of Credit Underwriting Practices, the OCC said its examiners also expect the level of credit risk to increase in both commercial and retail loan portfolios over the next 12 months.

“We are seeing trends very similar to those that examiners reported just prior to the most recent financial crisis,” said Jennifer C. Kelly, Senior Deputy Comptroller and Chief National Bank Examiner.

“The combination of increasing policy exceptions and easing of underwriting standards can increase portfolio risk to excessive levels and result in less resilient portfolios during times of stress,” the report said. “Boards of directors and senior management should carefully consider the impact of eased underwriting standards on the quality and volatility of performance in their loan portfolios, particularly for products that have already seen considerable easing over the past several years, such as leveraged lending, CRE loans, indirect consumer lending, and credit cards.”

Because they measure credit risk and distinguish individual credits and groups of credits based on the risk they pose, risk ratings are critical to helping bank managers and examiners keep tabs on changes and trends in risk levels, according to the OCC’s Comptroller’s Handbook on rating credit risk.

They, therefore, are subject to scrutiny during safety and soundness examinations. In the 2015 Sageworks Bank & Credit Union Examination Survey, 1 in every 6 financial institutions surveyed reported that examiners had criticized their institution or required action related to risk rating practices.

Risk ratings also determine pricing for loans and form the basis for the financial institution’s broader risk management practices, such as setting the allowance for loan and lease losses, stress testing, capital planning and strategic planning.

With Basel III focusing more attention on credit risk management, and the more granular review of loans required by the FASB’s proposed current expected credit loss (CECL) model, financial institutions can likely expect to see an increased emphasis by examiners on the importance and effectiveness of risk rating systems.

Sageworks hosted a free webinar on developing or enhancing a risk rating system. The webinar also discussed how financial institutions can leverage risk ratings in their ALLL and prepare for the Financial Accounting Standards Board’s (FASB) upcoming CECL model.

Watch the webinar, “Risky Business: Revamp Risk Ratings for Your ALLL.”