Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, February 26, 1995 TAG: 9502240038
SECTION: BUSINESS PAGE: F-1 EDITION: METRO
SOURCE: SAUL HANSEL THE NEW YORK TIMES
DATELINE: LENGTH: Long
Well, the only crunch now is the sound of bankers slamming into each other as they race to shower new loans on business and consumers.
But now that banks are lending again with gusto, helping to fuel the rebound in the economy, banking officials warn that the industry is getting caught up in another frenzy likely to end badly. The fear is that banks are taking too many risks and losing sight of some cautious practices instituted after the collapse of the commercial real estate market in the late 1980s.
To win all sorts of business - from loans for corporate takeovers to consumer credit-card accounts - bankers have loosened their rules again. As a result, they are lending more money at narrower margins for less collateral and with fewer restrictions than just a year ago.
``This past year we have really seen a deterioration of standards,'' said Verne G. Istock, chairman of NBD Bancorp in Detroit. ``Banks are planting the seeds of the next wave of problem loans.''
Loans at NBD were up 12 percent last year amid the boom in the Midwest. But Istock says that growth, however welcome, is also a warning sign: ``We're reminding our people that bad loans are made in good times.''
NBD is not alone. Despite rising interest rates, lending at the nation's banks is up sharply, as the banks rush to take advantage of the improving business climate.
The Federal Reserve says that the nation's largest banks had $1.141 trillion in consumer and commercial loans outstanding at the end of 1994, up a brisk 7 percent from the year before.
By comparison, total lending at these banks declined by 9.6 percent from mid-1990 to mid-1993, as they strove to recover from the problems created during the real-estate lending spree of the late 1980s.
No bank will openly admit to making bad loans, of course. But many bankers say that competition is forcing them to measures that make them queasy.
``We find ourselves being pushed right up to the line,'' said Sloan D. Gibson, the head of corporate lending at Amsouth Bank of Alabama in Birmingham, Ala. Amsouth, which increased its loans by more than 10 percent last year, admits it was only able to do that by cutting its interest rates and fees and easing its standards.
For example, Gibson said the bank now will make real estate loans that do not have the full personal guarantee of the property's owner. It also might make a secured loan of as much as 65 percent of a business' inventory when it feels that 40 percent is a more prudent level.
``The challenge for any bank is to not get caught up in the herd,'' Gibson said. ``You have to be willing to say, `There is a line I will not cross,' but that's hard to do.''
One measure of the gold-rush atmosphere is the interest rates and fees charged to borrowers, which are falling sharply, especially for loans to corporations.
Overall interest rates have risen, of course. But banks set the price of business loans as a spread - that is, a set number of percentage points above a floating interest rate.
For small and medium-sized businesses, interest is tied to their stated prime rate; for larger businesses, rates are tied to the London Interbank Offered Rate - known as Libor - which is the interest rate banks pay on large deposits.
The average interest rate on a loan to a big company with a comparatively weak BB credit rating has fallen from 1.3 percentage points above Libor in 1992 to .79 point above Libor at the end of last year, according to statistics complied by Loan Pricing Corp., a New York consulting firm.
Spreads for A companies fell from .40 point to .25 point. And while statistics aren't available, bankers say that rates for small businesses are declining at least that much.
Analysts say banks now are charging rates so low they are not really making a profit once money is set aside in reserve for inevitable future losses. At best, they say, much corporate lending is a break-even proposition for banks, offered to attract more lucrative business, such as money transfers or management of corporate pension plans.
Credit standards are harder to gauge, but there are signs that banks are lending more on looser terms. In the resurgent market for leveraged buyouts - corporate takeovers paid for largely with debt - the average bank loan represented 2.9 times the company's cash flow at the end of 1994, compared to 1.8 a year earlier, according to Loan Pricing.
Bankers also are making more long-term loans, which are riskier than loans that must be renewed every year. Last year 39 percent of corporate loans were for five years or longer, compared to 16 percent in 1992.
Another reason that this lending cycle may get out of hand is that many banks no longer worry as much about future losses because they sell large chunks of their big-loan portfolios to other investors, such as foreign banks and mutual funds. To the extent they off-load their loans, of course, the banks will not have to suffer for their mistakes.
For all the lending enthusiasm, standards have not slipped as far as they did in the late 1980s. And because the banks still are cleaning up past problems, the level of loans in trouble continues to shrink at most of them.
Moreover, when losses from the current round of new lending start showing up, banks should have a lot more capital to cushion themselves than they did five years ago.
Still, longtime bankers say that the compromises in standards look distressingly like the start of an apparently inescapable lend-then-lose cycle that has dominated banking for decades.
Apart from the commercial real-estate disaster, the years since the late 1970s have witnessed the Latin American lending spree; the Southwest oil drillers fiasco; the leveraged-buyout frenzy; and myriad other seemingly sure-fire propositions.
Some of the swing in bad loans follows from the ups and downs in the economy. Defaults on credit-card balances, for example, rise and fall in lockstep with the unemployment rate. But bankers have a history of amplifying the cycles, as they lend too much in good times and cut back too far when things get tough.
What is most worrisome, said L.M. Baker Jr., the chief executive of Wachovia Corp. in Winston-Salem, N.C., ``is that credit seems to be expanding faster than the economy.''
Wachovia, which increased its loan portfolio by 13 percent last year, has one of the best records of avoiding bad loans. Still, Baker says the bank is not immune to siren songs. ``Somewhere out there somebody in the bank has made a mistake. You just can't make too many of them,'' he said.
Other bankers insist that the industry has finally learned its lesson.
``We remember the trouble that we and many other banks had to work their way through,'' said Maurice Hastings, executive vice president for commercial lending for National Westminster Bancorp, the American unit of the big British bank. ``We don't plan to go through the same kind of pain again.''
Still, Natwest is trying to lend more money to small and medium-sized businesses in New York and New Jersey, where Hastings says competition is lowering prices and loosening standards. Natwest hopes to avoid problems by not permitting a big concentration of loans to one company or a single industry.
Indeed, the one discipline which banks seem to be maintaining is in the size of their loans. For the most part, they have cut the size of each loan they make.
``In 1988, you could do a $20 billion syndicated loan, because there were so many banks that said `sign me up for $100 million,''' said Christopher L. Snyder, Loan Pricing's president. ``You couldn't do a $20 billion syndication today, because banks won't hold more than $25 million.''
Banks are approaching lending to large companies as if they were underwriting bonds, selling small pieces to investors, typically regional and foreign banks and mutual funds. But, according to Mark Solow, the former head of corporate banking at Chemical Bank, that approach is fraught with peril if banks start to think they are lending other people's money rather than their own.
``The greatest risk is that people start to compromise on credit quality because they think they can sell the paper,'' he said. ``It looks too easy to people, and when things look easy that's when they get in trouble.''
Banks could be hurt if things turn bad and they hold an unexpectedly high inventory of loans, just as brokerage firms have been caught with holdings of junk bonds and mortgage-backed securities.
Moreover, somebody else stands to be hurt when things go sour, as is already evident from the collapse of the Mexican peso. The commercial and investment banks that arranged the deals are not the biggest losers in Mexico; instead, it is the mutual funds and pension plans that bought into the program.
No type of loan has emerged to dominate this new cycle, so nobody is sure where the next big problem will come from. Many worry about the rise of consumer loans. Others see small business as a potential sinkhole. But as always, the banks will not really know where the trouble areas are until it is too late to do much about them.
by CNB