Magazine article The RMA Journal

Credit Risk Challenges: During the Next 18 Months: At a Recent RMA Audioconference, Chief Credit Officers from Three Major Financial Institutions Discussed the Challenges That Will Face the Industry in the Months to Come. of Particular Concern Are Regulatory Scrutiny, Loan Growth, and the Economy

Magazine article The RMA Journal

Credit Risk Challenges: During the Next 18 Months: At a Recent RMA Audioconference, Chief Credit Officers from Three Major Financial Institutions Discussed the Challenges That Will Face the Industry in the Months to Come. of Particular Concern Are Regulatory Scrutiny, Loan Growth, and the Economy

Article excerpt

Regulatory scrutiny, loan growth, and the economy are major challenges facing the financial services industry during the next 18 months, according to the chief credit officers from three major financial institutions. Speaking during a recent RMA audioconference, these executives also expressed concern about the erosion of the risk/reward balance, increasing fraud, and the emergence of nonbanks in middle market and commercial real estate lending arenas.

"The ever-increasing drumbeat of agency guidance and best practices is injecting an unprecedented level of cost into credit risk management," said Jo Keeler, executive vice president and chief credit policy officer, Webster Bank and Webster Financial Corporation, Waterbury, Connecticut. "I'm not so certain it results in value added."

Robert Bojdak, executive vice president and chief credit officer, M&T Bank, and Cindy Manzetti, senior vice president and chief credit officer, Fifth Third Bank, agreed. "The Federal Reserve is probing areas that we've historically never even addressed," said Bojdak. "We're not sure if it's heightened concern or they're just looking for things, but it has led us down some interesting paths."

Loan growth, particularly growth that is accretive to the margin, is another concern in the current economic environment. "Growth prospects are hard to come by," said Keeler. "The opportunities to extend credit on a commercial basis in 2007 will continue the drumbeat of lowered spread, compromised structure, and lengthened tenor. It's troublesome because there is nowhere to run, nowhere to hide. The economy has covered a multitude of compromises in underwriting standards over the last several years."

A major concern for Manzetti is "what we don't know" because of the multitude of products being introduced and the shifting market for many products. "Risk managers relentlessly seek to keep the risk/reward ratio balanced," she said. "We watch all of the pertinent risks, but the environment is changing and it's complex."

Bojdak agreed that there has been continued erosion in the risk/reward balance. "Recovering from some of our pricing in the long term may be questionable. Are we ever going to make it back up on a spread basis as we have in the past?" he asked.

Contributing to this imbalance is the emergence of nonbanks into the middle market and commercial real estate lending arenas, said Keeler, noting that he includes in the nonbank category hedge funds and unregulated financial institutions. "They take a different view of the credit risk profile, creating pressure on underwriting for us."

Manzetti also is concerned about the increasing incidence of fraud. "While fraud is not principally a credit risk concern, loan fraud impacts us," she said. "A lot of times you can't see it coming. As an industry we have to be vigilant. The instances of fraud are increasing, and we need to find better and more collaborative ways to combat it."

Loan Structures

In this part of the credit cycle, the industry is facing volume and yield challenges. Loan structures and terms will continue to be tested. Manzetti says competition has always been a prime cause for loosening of terms and conditions. "Banks compete on pricing, structure, tenor, guarantees, and so forth," she noted. "Depending on the risk tolerance of any given bank, those elements can and may be flexed as more banks experience margin challenges that promote the drive for volume. And the way to get volume, other than to compromise the value-added of the relationship, is to craft structures, terms, pricing, and other elements to win the deal.

"The competitive drive for volume has always existed on the commercial side, but with the need for improved margins, it's going to increase. Not everyone knows what their true costs are when pricing for risk, leading to behaviors that do not benefit the customer or the lender. The lender's focus needs to be on providing the right solution at the right price for the customer and for the bank, not just on winning the business. …

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