Magazine article The Journal of Lending & Credit Risk Management

Credit Risk Challenges in the Next 18 Months

Magazine article The Journal of Lending & Credit Risk Management

Credit Risk Challenges in the Next 18 Months

Article excerpt

Volatility and uncertainty pose significant credit risks for banks today. A panel of three distinguished bankers discussed what they believe are the credit risk challenges facing banks during the next 18 months at an RMA audioconference in November 1998. Below are the comments of panelist William R. Barrett, vice chairman, risk management committee, J.P. Morgan Co., Inc. For excerpts of the comments of Peter R. Butcher, executive vice president, Union Bank of California and David L. Eyles, vice chairman, Fleet Financial Group, visit RMA's Web site at www.rmahq.org. Click on Journal Bonus.

The two industries that are at the top of my current U.S. worry list are healthcare and telecommunications. While each of these has unique risks, they are both being severely stressed by changes in technology and regulation. These stresses are not susceptible to conventional balance sheet and income statement ratio analysis. Nevertheless, it is critical to a company's future financial soundness that it be able to:

* Manage these changes.

* Use technology.

* Exploit regulatory opportunities.

* Defend itself from regulatory challenges.

Healthcare Industry

Healthcare service providers (excluding drug companies and the medical device companies) and the managers and underwriters of medical risk are being squeezed by regulations that try simultaneously to contain medical costs and to enhance patients' rights to the best possible care. Technology increases this problem by offering improved diagnostic procedures almost always at increased cost.

The regulatory environment has clearly been shaped by politics. We all want the best possible care for us, but we want them to pay for it. And the predictable result is that reimbursement mechanisms are so burdensome and complex that full compliance is probably impossible.

In addition, there seems to be a great uncertainty in the industry about which business models make sense. The waves of consolidation that created Columbia/HCA Healthcare Corporation (309 hospitals and 139 outpatient surgery centers in 36 states, England, and Switzerland as of June 1998) and Vencor, Inc. (long-term healthcare provider with 62 hospitals and 303 nursing centers in 45 states) seem to be reversing. Pharmacy benefit managers that were acquired a few years ago are now being divested. Revenues are under pressure. Earnings are under even greater pressure. While I think we were very lucky to escape a federally mandated central solution, what we've got at the moment has a level of turbulence that makes cash flow projections in the normal kind of credit analysis even more of a guessing game than usual and significantly increases the risk of unattractive credit outcomes.

In the face of this uncertainty, we've been trying to identify the stable sources of value and pick the likely survivors in an industry that does, after all, provide an essential service. We're looking for franchise value and we think that can come from a large customer base and from proprietary software to handle the reimbursement nightmare.

Franchise value also can come from a low-cost structure or the ownership essential assets. And we're much more likely to demand security and significantly higher lending spreads than would have been the case 12 months ago. We can't count any more on being refinanced by bond or equity issuance, so we want to get as close as we can to the real assets in order to be paid for the risks we are taking.

Telecommunications Industry

Telecommunications was a classic regulatory monopoly for years until technology freed the phone from the phone cord and new regulations encouraged the wireless revolution. In major markets there may now be as many as seven wireless licenses, at least three long-distance providers, and, more recently, local-access providers competing with the old phone company. In the near future, we'll probably see competition from cable, low-earth orbit satellite, and the Internet. …

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