Annual Reports
Banking in the Ninth
Supervisory staff at the Federal Reserve Bank of Minneapolis have long regularly compiled and updated a “risk list.” We are making key aspects of our list public to better communicate our assessment of current risks facing institutions and potential supervisory responses at firms we supervise. We welcome your comments on the list, which you can provide to Mpls.Src.Outreach@minneapolis.frb.org.
The list highlights current or emerging risks that could adversely impact supervised institutions along with potential supervisory responses. These potential supervisory responses reflect how examiners will assess these risks when present at an institution. In particular, examiners will determine if appropriate risk mitigants or management practices are in place to address these risks. They will also make recommendations to address any noted deficiencies. This list is periodically updated.
Federal Reserve Bank of Minneapolis Risk List - November 2011
Key Risks—Newly Identified and Repeat
Those risks or exposures currently affecting state member banks and bank holding companies in a significant negative way. Risks are listed in the perceived order of severity.
Emerging Areas of Concern
Those risks or exposures that are not currently having a material adverse effect at state member banks or bank holding companies, but which have the potential to do so in the near term (12 to 18 months).
Repeat Key Risks Currently Affecting the Portfolio
| Risk Description | Potential Supervisory Responses |
|---|---|
Loan Quality—Continuing issues associated with CRE; residential lending & HELOCs; ALLL methodologies; appraisal deficiencies; TDR recognition; risk rating accuracy; and incomplete global cash flow analysis. Also, guarantors who could have supported problem credits in previous years may be unable or unwilling to do so. |
Continue to focus examination and monitoring efforts on loan quality and credit risk management practices. Focus on continued willingness and ability of guarantors to support projects that do not cash flow. Provide reminders and additional training to examiners. |
High or increasing levels of OREO |
Include OREO in scope of asset quality review, as appropriate, focusing on appropriate recognition of loss, efforts to market properties, and compliance with state laws and accounting guidance. |
Concentrations |
Continue to review appropriate management of credit and funding concentrations, including consideration of concentration risk within a bank’s capital planning. Assess whether appropriate risk analytics are used when needed. |
Emerging Areas of Concern
| Risk Description | Potential Supervisory Responses |
|---|---|
Capital adequacy given asset quality and earnings deficiencies and limited options to raise capital |
Review sufficiency of capital planning at all institutions, paying particular attention to those whose financial condition shows early signs of deterioration or with low capital ratios. |
Interest Rate Risk—Immediate IRR concern is associated with increased risk-taking to chase higher yields in a low rate environment. |
Focus examination efforts on IRR management with attention to lengthening investment maturities or acquisitions with imbedded options. |
Earnings—Persistent low loan demand and rates are negatively impacting the NIM at most institutions. ALLL provisions also reduce earnings for some institutions. Increasing compliance costs and new limits on revenue sources may also reduce earnings. Banks may respond by taking on additional risks to increase earnings. |
Evaluate institutions’ plans for addressing earnings pressures. Ensure staff reviewing credits monitors changes in credit quality, structure, and terms reflecting increased risk appetite. Monitor continued support for critical functions (such as IT or Audit). Consider developing surveillance tools that detect higher risk-taking in asset mix. |
Deteriorating municipal bond and loan portfolios—As state and local revenues face continued pressures, bonds and loans to states and local governments face increasing risk of default. Those not defaulting could be devalued based on perceived weakness in the market. |
For banks with significant exposure to this sector, increase focus on prepurchase analysis and ongoing monitoring of this segment of the bond/loan portfolio. Evaluate stress testing and management’s awareness of emerging weaknesses. Continue activities to monitor the municipal bond market and communicate developments to staff. |
Other areas that warrant continued monitoring but are not currently considered to be key risks:
- Agriculture – The agriculture sector is strong within the district, as commodity prices in general remain well above historic levels. Agricultural land values continue to rise, with some rapid increases evident in select areas. Producers are experiencing robust farm profits. Strong prices for corn, however, will strain ethanol-related loans and will keep feed costs high for livestock producers. Many ag banks are experiencing limited demand for loans, and the potential for a material decline in land prices exists. At the same time, off-farm income may decline as economic conditions remain weak. Additional pressure may come from possible changes to federal government farm subsidy programs. We will continue to monitor developments in agriculture and complete an updated survey of our ag banks.
- Potential revision in ALLL Accounting – The FASB and IASB have proposed a new model for determining credit losses that would split financial assets into a “good book” and “bad book” based on credit risk management policies. Credit losses on the “good book” assets would be recognized on a new time-proportional basis, while the “bad book” credit losses would be recognized immediately. We will continue to monitor developments and the need for additional training and guidance.
