Comptroller's View: Too Much Credit Risk in Commercial Loans

In his continuing assault on deteriorating loan standards, Comptroller of the Currency Eugene A. Ludwig urged bankers in a letter this month to shore up portfolios while the economy is strong. The warning was prompted by the agency's third annual underwriting survey, which found that most national banks had eased loan standards this year. Edited excerpts of the letter follow.

The easing of standards for commercial loans noted in last year's underwriting survey has continued.

Although the 1997 survey finds that many banks have continued to tighten lending standards for many types of retail loans, the survey notes a continuing trend of increasing credit risk across both retail and commercial loans. In addition, because eased pricing was a frequently cited concession for commercial loans, the survey results suggest that many banks are not being adequately compensated for the increased level of credit risk in parts of their portfolios.

I strongly encourage you to consider the longer term effects on your bank of eased lending standards and increased levels of credit risk in your portfolios.

While the currently favorable economic climate has minimized the adverse effects to date, their consequences are likely to be readily and painfully apparent whenever the economy weakens. Longer tenors, less restrictive covenants, fewer guarantees, and weaker collateral positions will make it more difficult for banks to react to adverse economic developments and exercise appropriate controls to minimize loss on borrowers who become distressed.

I am also concerned about a trend among some banks, especially the larger ones, toward reducing staff and cutting expenses in their lending operations. I encourage banks to maintain strong credit control and monitoring systems designed to identify weaknesses in individual credits as well as industries and specialized lending portfolios, reduce exposures on weaker loans before they become distressed credits, and minimize losses on loans that do reach problem status.

Finally, as I indicated earlier this year in Advisory Letter 97-3, I believe that significant industry and supervisory attention should be devoted to advancing portfolio credit risk management practices. To that end, the OCC is developing examination procedures that will provide additional guidance on this topic for both banks and examiners.