Though Richard Ware 2d has had precious few problem loans lately, he is not sure what the future holds.
So Mr. Ware, chief executive officer of $1.25 billion-asset Amarillo National Bancorp, has sharpened the risk management tools of his Texas Panhandle bank.
He has developed a customized data base system so that his bank can revalue - on a daily basis - the feedlot cattle that are a large share of the bank's collateral.
When values fall below a target, the system triggers a margin call, and borrowers must come up with cash.
"So far, no one has had trouble meeting our margin calls, and that's during a terrible cattle market," he says. "But that can't go on forever."
Mr. Ware is not alone in his concern about credit risk. Though most community banks are enjoying strong profits and high loan quality in the current economy, a number of small banks are refining risk management procedures to make sure they are not caught flat-footed by the next downturn. As they well know, few things can sink a bank as swiftly as poorly managed credit risk.
In addition to computer systems that can revalue collateral, software is available to safeguard against too much lending to a particular economic sector.
For other bankers, added vigilance comes down to simply devoting more time and manpower to scrutinizing loan portfolios.
"You don't have to make a large investment to get the latest tools in risk management," said Richard Verrone, a bank consultant.
Recently, Mr. Verrone's firm, Verrone Consulting of Wrightsville Beach, N.C., helped Robert Morris Associates, or RMA, a Philadelphia trade group specializing in lending and risk management issues, to prepare "Beating the Odds: A Community Banker's Guide to Risk Management."
The report offers tips, including a grid that helps banks rate borrowers' riskiness based on how they score by various criteria, including debt service capacity, working capital, overall financial condition, and even management quality.
"A lot of this isn't rocket science," says Lee B. Murphey, chief credit officer at First Liberty Bank of Macon, Ga., and RMA's chairman.
Many community bankers have come up with their own remedies.
Take Mr. Ware. His bank - which was bought in 1906 by his great- grandfather - has long been a big lender to cattlemen. But it increasingly is harnessing technology to get the job done. The data base system, which cost about $30,000, is a case in point.
The system was obtained in the purchase of a small feedlot cattle specialty finance company several years ago. But the bank has upgraded it to be capable of tracking all its feedlot cattle loans.
In determining cattle's value at any point, the system can factor in the animals' expected daily weight gain while they are in the feedlot.
"We try to maintain a certain dollar value with cattle," says James Thompson, the bank's senior vice president for credit administration. "If the dollar value of the cattle goes below the loan value, that's when you start looking for margin calls. We ring up the customer and say we need 'X' dollars.
"If the customer can't make the margin calls in dollars," Mr. Thompson says, "then we have a right to hedge their positions."
The system's only failing, he says, is that it is not tied in to the bank's central financial accounting system. In the coming year, however, this will be remedied with the help of off-the-shelf data base software.
First Liberty's Mr. Murphey, too, upgraded his computer systems to manage credit risk - but using a different measure.
He recently completed a project that breaks down his loan portfolio by industrial groups. The system does more than simply give a reading of what percentage of the bank's loans lie in a particular industry, however.
The software groups industries that are likely to react similarly to economic shocks. For example, a cold snap might hurt not only peach farmers but also the trucking companies that serve them. Peach pickers, too, could have trouble meeting payments on their consumer loans.
Though some bankers are upgrading their analytical capabilities, others are simply devoting more time and attention to reviewing loans that might go bad.
David Kuhl, president and CEO of First Busey Corp., Urbana, Ill., has instituted quarterly "reserve for bad debt" meetings at each of the company's 10 bank branches. These sessions are followed by a major quarterly meeting at headquarters attended by the bank's public accountant.
"These branch meetings might seem kind of petty at times because we may be talking about a $1,500 loan," says Mr. Kuhl. "But it shows the (loan officer) that senior management is concerned about all loans, not just the big ones."
At Pacific Capital Bancorp, a $2.6 billion-asset holding company in Santa Barbara, Calif., executives have created a division of risk management.
Under the new system, all control functions, such as auditing, credit administration, and loan review, report to one executive - John McGrath, a senior vice president and director of risk management.
"We wanted to bring all of the control environment under one division," Mr. McGrath says.
Despite such steps, the strong national economy and correspondingly low chargeoff rates have generally reduced bankers' sense of urgency about credit quality. Last year, the ratio of net chargeoffs to total loans was 0.22%, according to Sheshunoff Information Services, far below the 1% and 2% levels recorded from 1987 through 1991.
"Very few people are losing sleep over credit quality," says Jack Goldstein, chief executive officer at First Frederick Financial Corp., a $110 million-asset banking company in Frederick, Md.
However, he maintains, "we need to be prepared for a coming recession. We don't believe that the current economy at this level is sustainable."
The nation's economy is looking as strong as ever. Gross domestic product surged to a 5.6% annual growth rate in the last quarter of 1998 - the fastest pace in two years. And inflation has fallen to a 0.8% rate, the lowest in 40 years.
But trouble spots are visible. In regions of the country dependent on the agriculture and energy industries, falling prices for goods have caused concern among many a lender. For the 12 months ended in January, the prices of West Texas intermediate crude oil fell 25%, corn 21%, wheat 14%, and beef cattle 6%
"Consider the impact on credit quality if commodity prices continue to decline or stay at those levels for one, two, or three more years," as they did in the early 1980s, says Allen Sanborn, RMA's president.
Joe Williams, the president of American Heritage Bank in El Reno, Okla., which is heavily involved in farm lending, says, "We believe we are already in a downturn and have been for at least a year."
Community bankers contacted for the "Beating the Odds" study expressed concern about the steady rise in personal bankruptcies in the past year, which some viewed as a leading indicator of personal credit problems. They also mentioned concerns about the impact of the Asian economic crisis on the U.S. export economy.
Community bankers queried in the study predicted that net chargeoffs as a share of all loans would rise to 0.39% by 2000.
Advocates of devoting extra attention to risk management talk about the changing nature of community banking. Gone are the days, they say, when a local banker could merely go on instinct and historical behavior to determine the riskiness of a loan portfolio.
Many community bankers, through acquisitions and marketing efforts, are putting new types of loans on their books with which they have little experience.
"When you acquire a community bank 100 miles down the road, your bank's credit officer doesn't know that bank's market as well as where he puts his head at night," says Mr. Murphey of First Liberty in Macon.
Adds Mr. Goldstein of Maryland's First Frederick, "Now we're lending to biotech firms, and there are new industry risks that we don't fully understand."
The growing interest in risk management shown by state and federal regulators should be reason enough for small banks to take the matter more seriously, Mr. Verrone said.
"When regulators go to a bank now, they ask about risk management systems," Mr. Verrone said. "They didn't do that three or four years ago."
For Mr. McGrath of Pacific Capital, it all comes down to common sense. Says he: "The best time to prepare for bad times is when you have the luxury of good times."