By Steven K. Beckner
Market News International - Federal Reserve Chairman Alan Greenspan urged bankers meeting in Las Vegas Wednesday not to overly restrict their lending to consumers and businesses as they deal with losses on past loans.
Greenspan, speaking via satellite to the Independent Community Bankers of America, said the economy's slowdown has exposed the "lax credit standards" and "overoptimistic assumptions" that banks used in making loans during the previous period of rapid growth.
As a result, he said, banks are tightening loan terms and standards as they experience "deteriorating" loan quality and earnings. He said this more prudent approach is "necessary and important," but urged bankers not to "overcompensate and inhibit or cut off the flow of credit" to sound borrowers.
On a day when the Federal Deposit Insurance Corporation reported near record bank earnings for the year 2000, despite a fourth quarter dip, Greenspan said banks are well set to deal with economic uncertainty but cautioned against excessive consumer and commercial real estate lending.
Greenspan did not address the economic outlook but acknowledged current economic weakness and uncertainty in saying bankers and their supervisors have to "re-evaluate past assumptions in this period of economic slowing and to initiate adjustments that ensure banking promptly adapts to conditions that are less certain and less robust than the extraordinary performance of recent years."
"After a near decade of unprecedented prosperity, the banking industry has come to recognize, not for the first time, the embedded costs of lax credit standards and the overly optimistic assumptions about borrower prospects that seem the inevitable consequence of ever-lower perceived risk premiums," Greenspan added, citing syndicated credits, "especially those to leveraged borrowers," as the biggest problem area.
Earlier, the Federal Deposit Insurance Corporation reported that bank earnings slipped, along with economic activity, in the fourth quarter to $17.8 billion from $19.3 billion in the third quarter. Earnings were hurt by a growing number of noncurrent loans, loans on which interest and principle payments are in arrears, that forced banks to increase their loan loss provisions. But earnings for the year were $71.2 billion, down only $400 million from 1999. Thrifts also posted their second highest ever earnings last year.
Alluding to the 2000 earnings results, Greenspan said, "Nevertheless, though the effects of these excesses are likely to continue for much of this year in the form of moderately deteriorating asset quality and earnings at some of the larger banks, these problems, one hopes, will prove modest both by historical standards and relative to the resources of these institutions."
"Fortunately, we move into a period of uncertain times with the level of the industry's overall profitability well above the average of recent decades," Greenspan continued. "Moreover, the source of banking revenues is better diversified than in the past, and most institutions hold strong capital and reserve positions.
Greenspan said it is not surprising that banks have tightened loan terms and standards "in response to past laxity, a weakening economy, and general economic uncertainty." He pointed to wider yield spreads on corporate loans, among other things.
The Fed chairman said these "adjustments in standards and pricing are clearly a necessary and important part of the transition that banks must make in moving from overly optimistic assumptions to more-realistic assessments of borrower prospects."
However, Greenspan went on to caution that "lenders and their supervisors should be mindful that in their zeal to make up for past excesses they do not overcompensate and inhibit or cut off the flow of credit to borrowers with credible prospects."
"There is doubtless an unfortunate tendency among some, I hesitate to say most, bankers to lend aggressively at the peak of a cycle and that is when the vast majority of bad loans are made," said Greenspan, adding, "A more disciplined, less pro-cyclical, long-term approach to lending that provides higher average risk-adjusted returns to shareholders is obviously in the self-interest of banks."
Although there have been problems with large corporate loans, Greenspan observed that other segments of the credit market "have remained fairly resilient. For example, commercial real estate loans are experiencing below-average delinquencies and net charge-offs, as are residential mortgage loans. Furthermore, credit card net charge-offs, which had escalated in recent years, have fallen to more moderate levels."
But Greenspan added a caveat. He said, "prudent bankers will need to weigh the potential for less-agreeable credit conditions." In particular, he warned about consumer lending. "In recent years, buoyant economic conditions raised expectations for continued growth in income and employment for consumers, which in turn have led to growth in household debt that has outstripped gains in disposable personal income over the past five years," he said, adding, "That growth in debt has pushed consumer debt service burdens to levels close to the peak experienced in the late 1980s."
Greenspan also issued a warning on commercial real estate lending, noting there has been a rebound in the volume of loans secured by office and other commercial real estate properties. He said "larger organizations have managed to keep their holdings modest relative to their asset bases either through securitizations or sales or by avoiding originations altogether." But he said "many smaller commercial banks have raised their commercial real estate concentrations relative to assets and capital."
"Though underwriting practices appear to be much healthier today than they were in the 1980s and standards have tightened somewhat recently, supervisors are paying particular attention to community banks with concentrations that make them materially vulnerable to a downturn in this market," Greenspan added.
Aside from asset quality, "a more lingering and widespread source of concern has been shrinking net interest margins," Greenspan said. "As liability costs rose rapidly last year, nearly all of the largest bank holding companies experienced margin declines, with about one-fourth experiencing a narrowing of 25 basis points or more since a year ago." This was not the case with community banks, he noted.
Banks, particularly larger ones, also face "liquidity" challenges as their core deposit base shrinks, Greenspan said.
"Community banks have experienced only moderate diminishment in the share of core deposits funding assets, but when that trend is coupled with rapid loan growth, pressures on bank liquidity appear to have intensified," said Greenspan. "Community banks have funded the gap between loan and deposit growth largely by liquidating investments. ... The combined deposit and loan trends have pushed liquidity benchmark ratios, such as loans to deposits, to historic peaks."
Greenspan saw "some signs of relief for bank liquidity." For one thing, he noted, "the demand for loans by businesses and consumers appears to be moderating, and there are some early indications that consumers are returning to bank retail deposits in the wake of disappointing stock and mutual fund results."
"Still, many of these liquidity pressures are likely to remain in one form or another, and banks will almost certainly continue to explore nondeposit liabilities to fund asset expansion," Greenspan added.
Greenspan urged banks to improve their risk management and to maintain "enough capital and reserves so that your organization can absorb the losses that inevitably occur as part of risk-taking in a strong economy."