WASHINGTON - The Office of the Comptroller of the Currency said Tuesday that banks should expect increased pressure on earnings next year and warned them not to compensate by easing underwriting standards.
"Don't try to cut costs by cutting loan review," warned Nancy Wentzler, the OCC's deputy comptroller for global banking and financial analysis. The rate of default in commercial loan portfolios is on the rise, she said, and though most of the pain is being felt by banks holding pieces of large syndicated loans, those problems could easily spread.
Ms. Wentzler urged banks "in all asset-size groups" to test their loan portfolios for weakness and to be sure that new loans are priced according to risk. "Banks need to be careful," she said.
The OCC's advice contrasts sharply with a Dec. 5 admonition by Federal Reserve Board Chairman Alan Greenspan that bankers and supervisors should "guard against allowing the pendulum to swing too far the other way by adopting policy stances that cut off credit to borrowers with credible prospects."
Asked whether the OCC believes banks are in danger of cutting back too much on lending, Ms. Wentzler said: "We don't see that. We see that banks are moving in a very positive direction. Risks are changing, and we would be appalled from a safety and soundness perspective if bankers did not adjust their standards."
Some observers attribute the conflicting warnings to the difference in mission between the OCC, which solely regulates banks, and the Fed, which regulates banks but also has responsibility for keeping the economy on track.
"Mr. Greenspan wears two hats, one as a monetary policymaker trying to help the economy, the other as a regulator hoping to improve asset quality," said Sung Won Sohn, executive vice president and chief economist at Wells Fargo & Co. "In times like this, those two objectives could actually conflict. If banks raise credit standards too much, the economy could suffer. That is an inherent conflict within the Fed."
Ms. Wentzler's remarks came during a press briefing on the OCC's quarterly Condition of the Banking Industry report, which found that U.S. commercial banks' return on equity had fallen to 14.25% in the third quarter, from 15.31% the previous quarter.
The report also listed plenty of reasons why banks should expect the decline to continue.
Noninterest income as a percentage of industry assets, which rose consistently throughout most of the last two decades, is on pace to fall to 2.55% for this year, from 2.64% in 1999, according to the OCC report. In the past such income has buffered bank earnings against declining net interest income.
"There is nothing on the horizon to suggest that noninterest income is going to take off any time soon," Ms. Wentzler said. "In the future banks may not enjoy the offset of noninterest income that they have had in times past."
After peaking in the first quarter, bank revenue from market-related activities, such as trading, asset management, and venture capital, has declined. Citing a "fairly close correspondence" to movements of equity prices in general, Ms. Wentzler said that regulators expect the fourth-quarter numbers to show at least a leveling off, if not a continued decline, in market-related revenues.
Further dampening banks' earnings is the erosion of core deposits.
Ms. Wentzler reported that 75% of U.S. commercial banks are expected to end the year with core deposits equal to 65% or more of their total assets. In 1992, 95% of banks met this standard.
Instead of using core deposits, banks are relying on funding sources that are more expensive and more volatile, such as brokered deposits and the commercial paper market, she said. This narrows the spread between the interest rates they earn on loans and what they must pay for funds, trimming the banks' profit margins.
Though there are reasons to be cautious, declining profits are not a sign of systemic trouble in the banking industry, Ms. Wentzler said. "Really, what we are talking about is an earnings issue, not a safety and soundness issue."
Banks remain well-capitalized, and earnings are starting their fall from a near-record high, Ms. Wentzler said. Declining earnings are to be expected as the economy descends from the "rarefied atmosphere" of the recent economic boom to "something more normal," she said.