INDUSTRY CONDITIONS & CONCERNS

Views expressed are those of the presenter and are not necessarily those of the Federal Reserve Bank of San Francisco or the Board of Governors.

INDUSTRY CONDITIONS & CONCERNS:

What Keeps Regulators Up at Night?

Regional Bankers’ Forum San Francisco, California

November 7, 2013

Wallace Young Director, Risk Coordination Unit

Risk Monitoring and Analysis Group Banking Supervision and Regulation

Federal Reserve Bank of San Francisco

12TH DISTRICT BANKING

CONDITIONS

2 November 7, 2013 Regional Bankers' Forum

Bank Profitability Continues to Recover


ROAA has Improved in Most States

* NV: excludes credit card and zero-loan banks


NIM Pressure Continues


Loan Loss Provisions are at 20+ Year Low


Overhead Expense Trends are Mixed


Average Core Profitability Edges Higher


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Non-Performing Assets Continue to Decline

November 7, 2013 Regional Bankers' Forum

Average Noncurrent Loan Rates are Declining

Noncurrent loans include all loans on non-accrual status, plus loans that are 90-days or more past due and still accruing interest.


Net Charge-Offs Approach Pre-Recession Levels


Loan Growth Slowly Returns


District Loan Growth Varies by Bank Size


C&LD Concentrations Decline to 20+ Year Low Relative to Capital

60% 40%

143%

26% 10%

60%

26%

0.0

25.0

50.0

75.0

100.0

125.0

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Mar

-13

12th District Banks Nation

14

Note: Data as of 1Q13


Liquidity Build-Up Appears Over


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Liquidity Build-Up Appears Over


Total Risk-Based Capital Ratios Inch Lower


Tier 1 Common Equity Ratios have Peaked


12th District CAMELS Upgrades Continue to Outpace Downgrades


Average CAMELS Component Ratings for 12th District Banks (1: strong; 2: satisfactory; 3-5: less than satisfactory)

CAMELS Rating Components Improve


Economic Political

Competitive Regulatory

Headwinds


SUPERVISORY HOT TOPICS


Earnings Challenges • Core earnings under pressure • Low interest rate environment narrowing margins and increased extension risk • Intense competition for quality borrowers • Limited opportunities to grow fee income, especially for smaller banks • Overhead expense headwinds

2005

2005

2008

2008

2010

2010

2012

2012

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

<5Y >5Y

Assets < $10 Billion

2005

2005

2008

2008

2010

2010

2012

2012

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

<5Y >5Y

Assets > $10 Billion

Total Securities & Loans by Maturity (% composition)


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Small and mid-sized banks (in particular) are taking on

more interest rate risk.

As longer-term interest rates increase, market value of

investment portfolios decline.


Liquidity & Sensitivity Challenges • Recent deposit inflows may exhibit more volatility than expected when rates rise • Recent changes in deposit mix, such as increases in nonmaturing deposits (NMD), may not be

sustainable • Historical models may not capture depositor behavior following prolonged period of low rates • Will banks that have extended duration on the asset side be able to reprice quickly on the

liability side?


Expansion into New or Unfamiliar Lending Areas • Banks are seeing rapid loan growth in some lending areas

o C&I: large banks; 1-4 family residential: mid-sized/small banks; multifamily: mid-sized banks • Concerns:

o Expertise in new lending areas may be lacking o Competition/pricing pressures are leading to some easing of underwriting criteria/terms o Historical loss rates on C&I are higher than most other loan types o Management must maintain robust risk management processes around all products


* Based on a panel of 341 District commercial banks without significant mergers, loan sales or loan purchases over the period. Each bar above is based on banks with at least 4% of loans in the particular loan type; prelim. 6/30/13 data

Cyber-Security • Banks are having to spend more money and devote more attention to making sure corporate and

customer information is secure. • A big issue for larger banks, but even smaller banks need to be concerned….particularly

serviced institutions.

Vendor Management • This is more than an IT (Information Technology) issue. • Banks are increasingly more reliant on 3rd party vendors and service providers. • Require comprehensive, risk based due diligence, monitoring, and reporting processes. • New regulatory guidance will be issued very soon.

Bank Secrecy Act/Anti Money Laundering • Increasing regulatory attention on BSA/AML compliance. • Banks that are engaged in foreign wire transfer activities are most vulnerable. • Several recent high-profile cases resulted in significant fines and penalties.


http://www.philadelphiafed.org/bank-resources/publications/consumer-compliance-outlook/ http://www.communitybankingconnections.org/

http://www.frbsf.org/banking-supervision/publications/first-glance-12l/


DODD-FRANK ACT UPDATE


Comments/Opinions on Specific Dodd-Frank Matters

To help ensure that the rule-writing process is conducted in a fair, open, and transparent manner….

Federal Reserve Board policy requires documentation of

substantive comments or recommendations on matters related to Federal Reserve rulemaking.

Comments are summarized on the Board’s public web site.

Formal written comments are invited via the Board’s web site. http://www.federalreserve.gov/newsevents/reform_proposals.htm


http://www.federalreserve.gov/newsevents/reform_proposals.htm

Major Dodd-Frank Act Provisions To address… DFA created / requires

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• Enhanced regulatory standards for large banks

• FDIC orderly liquidation authority (OLA)

Too Big To Fail

• Volcker rule (proprietary trading, hedge funds)

• Incentive compensation rules • Risk retention for mortgages sold

Excess Risk Taking

• Consumer Financial Protection Bureau (CFPB)

• Simplified products and disclosures

Abusive Lending


Recently Completed DFA Initiatives

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September 2013 • Stress Testing Requirements BASEL III Application and Transition Period (Interim Final Rules)

August 2013 • Supervisory Assessment Fees (Final Rule) July 2013 • Integrated Regulatory Capital Framework (Final

Rule) June 2013 • Swaps Push Out Provision Applicability to Uninsured

U.S. Branches and Agencies of FBOs (Interim Final Rule)

April 2013 • Retail Foreign Exchange Futures and Options (Final Rule)

• “Financial Company” Definition for SIFI Designation (Final Rule)

February 2013 • Federal Reserve Accounts and Services for Financial Market Utilities (Proposed Rule)

January 2013 • Appraisals for Higher-Priced Mortgages (Final Rule)


For additional information and resources related to new capital rules, see:

http://www.federalreserve.gov/bankinforeg/basel/

USImplementation.htm


New Capital Rule

• What is the effective date? – For most institutions subject to the advanced

approaches rule: 1/1/14 – For all other banking organizations (including

community banks): 1/1/15 – Some elements phase-in over time. All aspects of

New Capital Rule to be fully effective 1/1/19.


• Who does it apply to? – All Banks – Top-tier BHCs (not subject to the Board’s small

BHC Policy Statement) – Savings Associations – Top-tier SLHCs that are not substantially engaged

in insurance or commercial activities.


New Capital Rule

• Key Changes from the June 2012 Proposal – Residential Mortgage Exposures – Accumulated Other Comprehensive Income

(AOCI) – Non-Qualifying Capital Instruments and Tier 1

Capital – SLHCs


New Capital Rule

• Significant Changes from Current Capital Rule – Revisions to the Minimum Capital Requirements – Adjustments to Prompt Corrective Action Thresholds – Additional Improvements to the Quality of Regulatory

Capital – Capital Conservation Buffer – Credit Ratings – MSAs and DTAs – Revised Risk Weights


New Capital Rule

Questions?

November 7, 2013 38 Regional Bankers' Forum

Thank you!

Wallace Young Federal Reserve Bank of San Francisco

101 Market Street San Francisco, CA 94521 [email protected]

(415) 974-3166

Documents

INDUSTRY CONDITIONS & CONCERNS