What the Examiners are Examining
Banks, thrifts and credit unions are always wondering what regulators will focus on during their next safety and soundness exam. Based on our most recent Sageworks Bank & Credit Union Examination Survey, we can say that the answer is: credit quality, particularly in the area of commercial real estate (CRE).
While other areas also received attention, three quarters of respondents named asset quality as an area of focus by examiners from the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve and the National Credit Union Administration (NCUA). The survey found that some of the asset-quality issues receiving criticism from examiners included: risk rating systems; higher rates of delinquent and non-performing loans; loan reviews that weren’t completed annually or were inconsistent; and quality issues related to the financial institution’s growing pains, the overall economy or continued real estate devaluation.
All U.S. banks and credit unions are required to undergo a safety and soundness examination every 12 to 18 months, but the specific areas of focus of each exam can differ by agency, region, time period and the particular examiners involved, among other factors. While regulatory guidance about the exams is plentiful, many financial institutions seek additional information regarding how examinations may progress.
Earlier this year, we initiated a survey of institutions that had recently undergone examinations, aiming to provide greater clarity into current examiner expectations, especially surrounding specific areas such as credit administration, the allowance for loan and lease losses (ALLL) and asset quality. Representatives from 165 financial institutions participated in the online survey, conducted between May 17 and June 13. Poll respondents, who were not randomly selected, included Sageworks financial institution clients as well as members of the “ALLL Forum for Bankers” LinkedIn Group and recipients of Sageworks newsletters. They included chief financial and chief credit officers, credit analysts, compliance and risk management staff, and bank and branch presidents.
When asked what areas examiners had focused on the most during their recent examination, more than a quarter of respondents chose capital adequacy, while roughly one in five said examiners focused on market risk. Less frequently mentioned were liquidity, earnings and management. Respondents were allowed to identify more than one area of examiners’ focus.
Open-ended answers from respondents showed that financial institutions received criticism for a variety of issues. Among those named most frequently in these responses were real estate valuations and concentrations, loan administration (especially documentation exception issues), as well as the calculation and methodology of the ALLL.
“Concentrations and Portfolio Management of CRE credits received the most criticism,” said one banker, noting their institution has a growing CRE portfolio that is approaching regulatory thresholds. Several institutions said they were dinged for outdated or absent appraisals for real estate. Other criticisms related to documentation: adequate documentation in loan files, collecting financial documents in a timely manner and documenting decisions on risk ratings.
Documentation of the ALLL also drew attention during exams, according to respondents. “Document everything!” said one banker of an institution with between $2 billion to $10 billion in assets examined by the OCC. “Every assumption you make, every calculation process, every reason for why you do it the way you do.”
Two additional themes in financial institution responses were that stress testing is being evaluated and recommended strongly in some exams and not in others, even when examined by the same regulatory agency, and that there is frustration among financial institutions about changing requirements and standards of evaluation from exam to exam.
Other financial institutions reported a smooth examination process. From one financial institution with between $500 million and $1 billion in assets that was examined by the OCC: “Our most recent exam was one of the cleanest we have ever had.” Another financial institution with between $75 million and $500 million in assets that was examined by the FDIC reported “no serious criticisms.” Even so, the respondent noted, examiners “still worked through loans with a fine-toothed comb.”