Rocky road ahead for bank profitability: OCC

WASHINGTON — The coronavirus pandemic will put continued pressure on earnings and credit quality as the industry adjusts to a new normal, but the total magnitude of the impact on banks is still uncertain, the Office of the Comptroller of the Currency said Monday.

In a semiannual report on the national banking system, the agency highlighted risks to bank profitability resulting from tightening net interest margins and mounting loan-loss provisions. The agency said “provision expenses [are] expected to remain high while net interest income and margin pressures increase from the collapse of the yield curve.”

“Banks substantially increased their loan loss provision expenses in the first quarter of 2020 reflecting the expected increases in loan losses in the coming periods,” the OCC said in the report. “Second quarter provision expenses are expected to substantially increase as the extent of the economic downturn develops.”

Still, a resounding theme in the report was uncertainty about the months ahead, making it hard to gauge the entire effect of the public health emergency on the banking sector.

In a semiannual report on the national banking system, the agency highlighted risks to bank profitability resulting from tightening net interest margins and mounting loan-loss provisions.

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“Bank profitability remains dependent on the depth and duration of the economic downturn that is difficult to predict,” the OCC wrote in its most recent Semiannual Risk Perspective.

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For example, the degree of a decline in net interest margins will hinge on a number of factors. Ultimate margin pressures are “uncertain given the volatile rate environment and global pressures, which may encourage banks to take additional risk.”

“Risks include reducing credit standards, yield chasing for longer term assets, or entering new products or services to mitigate the NIM compression,” the OCC said.

The release of the report was delayed after a planned publication date earlier this year was put on hold because of the virus outbreak.

The economic shutdowns in the spring have posed tremendous credit and operational risks for banks, the report said. “Nearly every asset class on banks’ balance sheets has been or likely will be affected” by the pandemic, the report said, particularly in commercial lending. “Companies and industries face elevated risk of default, bankruptcy, or dissolution due to the sharp decline in revenues coupled with uncertain near-term prospects for recovery as well as longer-term uncertainties.”

At the same time, the demands from depositors and government economic recovery programs for banks to support the economy is causing balance sheets to bulge.

“Substantial deposit inflows, credit line draw downs, and new government programs contributed to larger balance sheets and a new set of financial risks including deposit stability uncertainty,” the OCC wrote.

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Beyond financials, the OCC also emphasized the cyber and fraud risks associated with banks and customers conducting business remotely.

“Malicious actors continue to target the financial industry with disruptive attacks through phishing, destructive malware, ransomware, and other cyber threats,” the OCC wrote. “The trend of increased criminal activity is expected to continue for the foreseeable future and may increase further as banks navigate through the economic disruption.”

But on the whole, the OCC suggested that the financial system remains a source of strength for the rest of the economy. “Although markets deteriorated rapidly, bank liquidity was minimally affected, and banks remained well capitalized,” the agency said.

In a call with reporters, acting Comptroller Brian Brooks cautioned that much of the data in the report is lagging. Most of the OCC’s bank-specific figures in the report date back to the end of 2019.

“I think we all can agree that 90 days ago, the world was a very different place,” Brooks said. “Over the last 90 days because of state and local responses to COVID-19, we are now facing more uncertainty.”

Asked about changes the national bank regulator was considering to react to the fast-moving economic environment, Brooks said that the OCC was in the midst of hiring a new chief economist who “among other things will be looking at modeling aspects of the macroeconomy in some different ways than we’ve done in the past” but declined to share further details.

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But Brooks also said that some recent economic data suggested the possibility of a faster recovery, reiterating an optimistic view from last week.

“Despite the volatility and gloom that generally seems to pervade the economy at the moment — and those things all create the potential for economic weakness to linger going forward — we do see a number of indicators, more recent than the data on which our report is built, that give us reasons to be optimistic as states start to reopen,” Brooks said. He pointed to double-digit increases in new home sales and in retail sales.

Brooks also told reporters that he largely agreed with the Federal Reserve’s decision last week to suspend stock buybacks but not introduce a wide ban on paying out dividends.

“Our view, like the Fed’s, is that we need to be measured about all of this,” Brooks said.

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