The Memory of Risk

Now that the housing market is on its way to recovery, the government is afraid that people have short memories. The financial risk that decimated the American economy just a few years ago still looms large in the government’s eyes, and they are clearly worried that we no longer believe in its ghost, giving weight to the idea that it may come back haunt us.

On September 11, 2013, Deputy Comptroller for Credit and Market Risk Darrin Benhart discussed risk and risk management associated with mortgage lending at a conference hosted by the Mortgage Bankers Association.  The Office of the Comptroller of the Currency is urging banks and lending institutions to increase oversight of the home appraisal process.  They’ve issued warnings to beware of sudden spikes in delinquencies on home-equity loans, akin to those that heralded the housing bubble burst.

Benhart highlighted two particular resources: The OCC’s Semiannual Risk Perspective and the OCC’s Mortgage Metrics Report. Insights from these reports pertained to risks facing the broader banking industry and trends that are being seen specific to mortgage lending.  He concluded by discussing some of the regulatory reforms underway aimed directly toward mortgage lending.

The OCC’s Risk Perspective for the Industry

OCC highlighted three key risks themes that banks should understand and seek to mitigate:

  1. Strategic risk continues to increase as bank management searches for ways to generate acceptable returns.
  2. Challenges arise in a period of sustained but slow growth as we are now experiencing. Many banks “chase” yield in this environment, often taking on more interest rate or credit risk to maximize return. Bankers are starting to layer risk back into the system.
  3. Operational risks continue to be a major challenge facing banks of all sizes. This includes increasingly sophisticated cyber threats, expanding dependence on technology, and changing regulatory requirements.

Outlook for Mortgage Lending

Although existing home sales have shown recent growth, these sales often result in a transfer of debt, rather than new growth. Some home price appreciation is increasing at a pace that isn’t consistent with other economic indicators. This situation raises potential questions about the sustainability of the pace of appreciation, a factor that OCC will be monitoring.  Benhart stated that “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.”

His conclusion worked a bit of necessary optimism in while given OCC’s honest truth. “There is steady improvement in the performance of mortgage portfolios overall, and banks are well positioned to participate in an economic recovery. However, we must remain vigilant not to let unmanaged risks slip back into the industry. Communication with your regulator is key especially as new regulatory reforms come online. Finally, you need to ensure your risk management function is multi-dimensional and looks at all risk across the entire bank. That requires work both by regulators and by industry participants.”

OCC’s entire presentation can be found here.

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