WASHINGTON - As the 2004 Shared National Credit exam wraps up, federal regulators have set their sights on sweeping changes to the annual review of large corporate loans.
This fall the four banking and thrift agencies plan to issue for public comment two proposals designed to leverage the industry's risk management advances and reduce the exam's administrative workload.
The coming overhaul "has a lot to with our being more efficient in how we use resources and reducing the burden on the banks," said Barbara J. Grunkemeyer, the deputy comptroller for credit risk at the Office of the Comptroller of the Currency.
The current process, she said, "is a massive undertaking for both sides, for the regulators and for the banks, and this would enable us to look at the credits that are probably most critical to understanding what's happening to risk in the portfolios."
Both proposals are being influenced by the impending Basel II standards, which will base the regulatory capital levels of the largest banks on sophisticated models weighing the risk posed by various assets. Regulators want to put these improved risk management tactics to work to help ensure a safe and sound industry.
"The reality is banks are using these internal ratings systems and collecting electronic databases that they use to help measure their own risk," said George French, the deputy director for policy and examination oversight in the Federal Deposit Insurance Corp.'s supervision division. "It would be unfortunate if the regulators did not find a way to tap into that information."
The Shared National Credit exam began in 1977, but regulators did not start publicly releasing the results until 1999. Hundreds of examiners review thousands of credits over $20 million that are shared by three or more regulated lenders. The bulk of the exam is conducted in May. The agencies crunch the results over the summer, deliver loan ratings to lead banks in August, and release aggregate results in the fall.
This year's results are expected to be better than those of last year, when examiners classified 12.6%, or $207.4 billion, of the $1.64 trillion reviewed.
"It's definitely improved. It's no surprise [the exam is] tracking bank asset quality. It might even be more favorable, but we don't really have full data yet," said David M. Wright, the assistant director for credit risk in the Federal Reserve Board's supervision division.
The number of appeals by bankers objecting to an examiner's rating have declined in recent years, but the agencies expect more this year. "Whenever ratings are changing, whether it's up or down, that's when you can get the most number of disagreements," Mr. Wright said.
One of the proposals would update the ratings used to classify a loan's quality - currently "loss," "doubtful," and "substandard." Rather than expanding the number of ratings, the regulators' goal is clarifying the factors driving a loan's classification. Such "two-dimensional" ratings take into account the quality of the borrower and the strength of the loan's terms, such as available collateral.
"We want to untangle the two components - the borrower's strength and the facility's strength - and then see where the combined conclusion leads," Mr. Wright said.
The second, much broader plan would overhaul the process itself, making the point-in-time exam a more continuous review. It would expand the scope and depth of the data collected but would involve fewer lenders, perhaps just the 20 largest of the 130 that agent SNC credits.
Preliminary plans envision these lenders' using electronic exchange to provide a standard set of data to regulators, including internal loan ratings plus the probability of a default and loss given default - terms developed as part of the Basel II capital accord. The goal is to help the agencies spot credit trends sooner.
While the details are far from set, regulators are considering collecting this data not just on credits the largest lenders lead, but also on loans they buy from other agents. That would allow regulators to compare the assessments of a single credit by several different lenders.
"We would propose a quarterly submission for the 20 or so largest agent banks, and this would allow better understanding of how conditions are changing over time, which would allow us to get more comfortable - or more concerned - over the course of the year," Mr. Wright said.
As an inducement, the agencies would share the database on these credits. Access to the data would be a big plus for bankers, because about two-thirds of these loans finance private companies that issue scant public information.
"That's a huge carrot because benchmark data is a key risk metric for the industry," said Pam Martin, the director of regulatory affairs at RMA-the Risk Management Association in Philadelphia, which represents bank credit and risk officers.
Mr. Wright said the database would help banks "understand how they compare to others and might lead them to review their methodologies to see if there are ways to improve, or it might just challenge some assumptions they've made" about industries or borrowers.
"The idea really isn't to say that anyone is right or wrong," he said, "but just to give a benchmark, a frame of reference, a place to start discussions about outliers, and to try to understand why their risk estimates tend to be biased, either conservative or optimistic, relative to their peers."
Mr. French said, "If there are persistent outliers or banks that tend to be much more optimistic in their ratings than others, then that issue could be explored."
Basel II is not expected to be implemented in this country until 2008, and it may take that long for a new Shared National Credit exam as well. Regulators envision a two-step process - a broad call for comments this fall followed by a more detailed proposal and a second round of industry input.
While bankers have not received much information about the plan to change loan ratings, they have told regulators that they want the Shared National Credit exam simplified.
"It's a mammoth undertaking," Ms. Martin said. Industry reaction will turn on how much effort and money the specific proposal will require as far as new systems to provide the standardized data and how much benefit bankers reap from the results the regulators promise to share.
"There is reticence on the part of the industry to have this constant system churn," she said, "to come up with some new way to give somebody some data when the industry is scrambling to stay on top of the demand for data now."
Neither change is expected to be finalized in time for next year's exam, but the agencies will continue to make more use of sampling techniques and other means of focusing on the riskiest credits.
Over the five year-period that ended in 2003, the number of credits examined declined 8.3%, to 8,232, while total dollars involved dropped 10.3%, to $1.64 trillion. Some of that decline can be attributed to the slowdown in corporate lending, but it is also because regulators are honing their attention on the riskiest loans.
"We've discovered - I don't know why it took so long - but we've discovered we don't have to look at all those triple-A and double-A rated credits," Ms. Grunkemeyer said.
