Magazine article Journal of Commercial Lending

Asset Growth versus Asset Quality

Magazine article Journal of Commercial Lending

Asset Growth versus Asset Quality

Article excerpt

In this article, an experienced loan officer points out that the pursuit of asset growth should not compromise asset quality. He reminds readers that the current lending environment hearkens back to the condition of the industry at the end of the last credit crisis. The author also provides a list of questions that may serve as a checkpoint for managers to assess any possibly forgotten credit fundamentals.

In 1989, when the banking industry was beginning to recover from the credit problems of the 1980s, a group of RMA volunteers began to wonder what RMA might do to help credit administrators and credit grantors assess their operations to highlight any shortcomings that might have contributed to the industry's credit problems. The goal was to encourage the industry to examine the way loans were made, so the next time the credit cycle turned, previous deficiencies would be corrected and the lending frenzy leading to the last credit downturn would not be repeated. It was thought that an enlightened industry might finally be able to learn from past mistakes and, for once, history would not be repeated.

This goal grew into the awareness campaign Focusing on Fundamentals, which kicked off in 1990. In 1991, it was the overall theme of RMA. Even today, elements of this campaign are being used by RMA whenever there is a need to focus the industry's attention on the most basic elements of credit risk management.

Judging from comments at the time, Focusing on Fundamentals was a very successful campaign. The forgotten fundamentals that were reintroduced to the industry caused many institutions to reassess how they transacted their credit business.

In February 1995, as the lending environment was beginning, once again, to show early signs of stress, the RMA Board of Directors began to ask what was happening to credit and underwriting standards. This discussion was followed by a poll asking participants to evaluate certain specific underwriting trends. The results clearly showed that underwriting standards were beginning to be loosened within the industry. Another survey was recently undertaken, and it is probable that it will report a continuing relaxation of credit underwriting standards in markets across the country.

Trouble Ahead

Curiously, when credit policy officers are asked if they have noticed a relaxation of underwriting standards on loans for which they compete, most would probably answer, "Yes, but not at my bank--although I have seen the competition doing some really stupid things." This type of response suggests that the seeds of a potentially troubling set of circumstances are being sown. What constitutes an acceptable degree of risk may not have the same meaning to a credit policy officer as it does to today's line lending staff.

There is probably no chief credit policy officer who would admit that his or her bank is guilty of any intentionally "stupid" underwriting. Some, however, might admit that certain guidelines may have been relaxed but not to dangerous levels. Yet when I speak to loan officers at my bank who are engaged in the daily competition for quality asset growth, they perceive an overly dangerous competitive environment, especially when the bank is competing against regional or superregional institutions.

Line lenders and loan division heads are receiving conflicting signals. As earnings within the industry begin to reflect early signs of flattening, there is severe pressure to increase loan production. Asset growth will help drive up earnings, at least in the short term, so loan officers, at some institutions, are being told to make more loans. As such, line lenders may be getting the wrong message. After all, as the saying goes, Lending money is an easy job: All you have to do is say yes.

Credit Policy versus Credit Practice

Clearly, there are indications of a conflict between credit policy and credit practice. …

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