Academic journal article ABA Banking Journal

Boom and Bust All over Again?

Academic journal article ABA Banking Journal

Boom and Bust All over Again?

Article excerpt

Anyone interested in asset quality and credit discipline should read Kelly Matthews' excellent commentary on the subject in The Economy, beginning on the following page. He observes, as others have recently, that the signs are pointing to an erosion of credit underwriting standards. What makes his treatise particulary interesting is that he offers an explanation of why this is occurring, and how difficult it is to resist the trend given the realities of the marketplace.

The discussion is particulary timely because it is a key element of what the Federal Reserve is trying to do with interest rates.

Another banker addressing credit standards is John Medlin, chairman of Wachovia Corp., Winston-Salem, N.C. He raised the issue in a speech in early April. One of Medlin's points was, "Cheap and easy credit always creates false prosperity and an eventual downturn." Medlin, who retired as CEO last year, was traveling at the time this was being written, but Wachovia's Chief Credit Officer Mickey Dry offered some additional insights on the current credit climate.

He confirmed that easier loan terms and lower prices were working their way through the whole spectrum of credits, from AAs to middle market. In particular, he noted that maturities had been lengthening due to competitive pressures, but that loan covenants were not being strengthened accordingly.

Pricing has deteriorated, he said, but not to the extent it did during the leveraged-buyout frenzy a few years ago. Further, bankers have stayed with cash-flow-based lending so far versus the balance-sheet lending prevalent in the last boom. That's good news, but still the question arises, can banking as an industry avoid the boom-and-bust credit cycles seen since the early '80s?

Considering the wrenching credit problems many banks experienced only a few years ago, you'd think the answer would be an unqualified "yes." However, as Dry observed, "Earnings pick up and people become intoxicated with the absence of problems." For sure, record earnings two years running is heady stuff.

And as Kelly Matthews points out, there's a lot of pressure to maintain those high earnings. Problem is, several of the elements driving them (higher spreads, reduced loan-loss provisions) have pretty much topped out. …

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