Asia's economic turmoil will cut profits at individual banks in 1999 but is not expected to cause widespread problems for the U.S. banking system, a government economist said Tuesday.

"The U.S. economy will see a slowdown because of the Asian problems," said Nancy Wentzler, director of economic analysis at the Office of the Comptroller of the Currency. "Consequently some credit problems in bank portfolios may result in reductions in bank earnings."

Ms. Wentzler, who made her comments during a briefing on general industry trends, said banks must be more diligent in dealing with customers doing significant business in Asia, including aircraft companies and automakers. "We expect other manufacturing categories such as chemicals and some agricultural businesses may be hit by international events as well," she added.

Paul M. Dorfman, executive vice president for credit and country risk management at Bank of America, agreed loan losses will increase as borrowers dependent on the region for revenues run into trouble repaying. "But will this be a huge disaster? I'd be awfully surprised," he said in an interview.

Mr. Dorfman talked to roughly 150 of the agency's senior field examiners Monday about the effect Southeast Asia's economic problems could have on U.S. banks.

Ms. Wentzler said bankers must evaluate their portfolios on a loan-by- loan basis because some customers' exposure to Asia will be worse than others. "This takes a bit of additional diligence on the part of banks and (the OCC's) supervisory staff to get below the surface and look at individual credits."

Several domestic factors are also likely to reduce bank profits during the coming year.

"We see some weakening in earnings potential through shrinkage in margins, competition, and loss of cost savings," she said. In addition, the record profits of recent years have lulled banks into allowing their loan underwriting standards to slip.

Common underwriting deficiencies include poor documentation of borrowers' financial positions, insufficient monitoring of changes in customer finances, and little review of shifts in collateral values, Ms. Wentzler said.

With the economy likely to slow down, banks are expected to increase their loan-loss reserves, putting additional downward pressure on earnings and average return on assets. "Reserves as a percentage of loans are now 1.83%-the lowest level in over a decade," she said. "The issue here is whether banks have sufficient reserves in light of recent changes in underwriting practices and economic conditions."

Earnings at large banks, those with assets over $10 billion, will be under the most pressure, she said. During the first quarter of this year, return-on-equity at large banks dropped to 14.6%, off from 16.4% during the first quarter of 1997.

Ms. Wentzler blamed the decline on intense competition in big banks' key markets, shrinking syndicated lending margins, and the difficulty of managing large institutions.

Because of those problems, she said bank mergers will be driven by a desire to add new product lines or geographic markets, rather than to cut costs. "Reliance on cost control as a source of internal revenue has been a major story in recent years. Unfortunately, that story may be developing a new plot. It may be curtailed."

Ms. Wentzler noted that the ratio of noninterest expenses to net operating revenues industrywide increased to 62% in the first quarter from 60.5% in the same quarter of 1997.

To compensate for the rising costs and shrinking loan margins, banks are increasing fee income from loan servicing and credit cards. Noninterest income rose to 39.7% of net operating revenue in the first three months of this year from 36.8% in the first quarter of 1997. The thirst for more fee income will drive large banks to develop new derivatives products to help customers manage various risks, said Ms. Wentzler.

"This area very likely will be a continued source of activity for banks given their comparative advantage in credit assessment and the expected demand for such products in a churning global economy," she said.

Still, banks must monitor the new instruments carefully, she warned. "We have not seen a real market test for nontraditional instruments such as credit derivatives and risk models."

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