WASHINGTON - Mike Brosnan worries for a living.

It's a tough job being the comptroller of the currency's risk expert, considering that the banking industry that has turned in nine consecutive years of record earnings. But profits do not pacify Mr. Brosnan, who has been criss-crossing the country warning bankers about credit, liquidity, and interest rate risk.

He repeatedly asks them: "You can eat well, but can you sleep well?" The question is supposed to make the bankers examine whether they are sacrificing long-term viability for the short-term profits needed to meet investors' expectations.

"Earnings have always been an issue, but you have never seen the pressure that anybody who is publicly traded faces now," he said in an interview. "There is a disincentive to spend in the short run, because you've got this [earnings] number you have to meet on Sept. 30."

The first budget item to be cut, he said, is often risk management tools like auditors. "Bankers are trying to simultaneously grow revenues and manage expenses, and if you manage your expenses too far, you will fail to invest in quality infrastructure."

If the economy turns down - a big if, Mr. Brosnan is careful to note - then some banks "aren't going to make it, and we're already seeing signs of where the separation [between survivors and failures] is going to occur."

Those signs are being provided by Project Canary, the early-warning system that Comptroller John D. Hawke Jr. unveiled last fall. Now largely in place, the computer system ranks national banks on 15 benchmarks developed by the agency's most experienced examiners. Six relate to credit risk, four hit liquidity risk, and five measure interest rate risk. (See chart.)

Of 2,400 national banks, Mr. Brosnan said, 450 breach three or more credit benchmarks, 310 breach liquidity, and 460 breach interest rate risk.

"All these are barometers," he said. "This shows where the bank likes to take its risk, and arguably make its money. There is no way of knowing … with the simple system we've built, how well that risk is managed, and that's the key."

So the Comptroller's Office is asking examiners to interpret the data and determine which banks need a closer look.

"Don't be surprised," Mr. Brosnan warned. "We are going to target certain banks and look for certain things because of financial positions."

While some of the benchmarks are obscure and his sermon is stuffed with complicated charts, the senior deputy comptroller for risk evaluation is the king of declarative sentences such as, "Most banks are not very good at managing interest rate risk." In Mr. Brosnan's book, simple is better. To wit, this advice to bankers evaluating hedging products: "Have big eyes and ears. Nothing is free."

And here is his take on the sophistication of risk modeling systems, "We don't expect everyone to have the starship Enterprise."

Maybe that's why the comptroller has Mr. Brosnan, 42, out on the road talking to national banks, which hold 60% of the industry's assets.

It is precisely banking's unprecedented profits that alarms Mr. Brosnan. He points to the spread between the industry's average return on equity, just over 16%, and the yield on 10-year Treasury bonds, roughly 6.4%.

"This 9.6% [spread] is the biggest we've seen," he said. "The bigger this number gets, it would suggest more risk is being taken to generate" returns so far above Treasury obligations, which are considered a risk-free investment. "You could do business risk free by just investing in Treasuries.

"So risk exists in the banking industry, and it's not little."

Leverage also puts Mr. Brosnan on edge: Consumer debt topped $6.5 trillion this year, up from less than $4 trillion in 1992. Much of this is secured by a home, so it's relatively safe. But corporate debt is another matter.

Bonds and commercial and industrial loans stand at $4 trillion, up from $2.5 trillion in 1992. Corporate customers began spending more in 1996 than they brought in, which Mr. Brosnan calls "negative free cash flow." This means borrowers must keep borrowing to grow, and Mr. Brosnan said there is no end in sight for this trend.

"This is the dark cloud of the bull market," he said. "With all this debt built up, should you ever have a downturn … then the companies that have borrowed all this money, it will take them a long time to work out of it."

As he puts it, "this would kick some major sand in the wheel of the U.S. economy."

The sheer size and volatility of financial markets, he notes, can magnify missteps. "Things happen quickly and on a large scale."

Finally, Mr. Brosnan worries about where banks are going to make money in the future. "Core bank earnings are compressing."

The backbone of bank earnings - net interest income - has been "flat or slightly declining for some time," he noted.

Lending has ballooned, outstripping deposit growth. That has led banks to more expensive funding sources, which require more sophisticated management. "If you're going to rely on professional markets and use short-term money, you have to be pretty confident that you've got strong asset quality, stable earnings, and stable bank management," Mr. Brosnan said. "If you don't have those things, that money will roll out."

Banks have continued to boost profits by increasing fee income, cutting expenses, and trimming reserves. But as they expand their product mix, banks must also spend more on risk management. "What I worry about the most is that they are not investing as the business gets more unique pieces," he said. "How does audit and review keep up with new products on the same budget?"

And loan loss provisions, declining since 1992, are now at 1985 levels, and Mr. Brosnan predicted banks will again start adding to reserves.

"Earnings will come down," he said. "What we are telling our examiners is don't judge a bank by whether or not it makes 20% or 22% return on equity or 1.5% return on assets."

Those numbers can be deceiving, he said.

"There are some banks that have managed their accounting numbers to look pretty good," Mr. Brosnan said. "They have failed to invest, so their numbers look really good."

Examiners are being told to look for the banks that keep on posting solid numbers. "If a banker can do that for 25 years, he is going to win."


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