Bankers Are Smiling, Warily

By Charles Alexander

Profits are up, but strapped borrowers still worry the giants of finance

The party last week at Georgia Governor George Busbee's mansion in Atlanta befitted the wealth and financial power of the guests. Strolling under tall oaks on the sloping lawn, hundreds of gray-and blue-suited bankers sipped wine and Jack Daniel's whisky and picked away at whole pigs barbecued over beds of charcoal, bins full of breaded

chicken breasts and mounds of

black lumpfish caviar, smoked trout, salmon and shrimp. Crooning in the background were the Augusta Singers, a group of black balladiers. The bash, hosted by the Governor and Atlanta's Citizens and Southern National Bank, was the high point of the annual meeting of the American Bankers Association, which had attracted to Georgia's capital some 10,000 financial executives from across the U.S.

For the first time in many months, bankers had reason to feel festive. An easing of monetary policy by the Federal Reserve Board and the sharp break in interest rates have given a boost to bank earnings. After having been severely depressed during the summer, bank shares are among the hottest stocks in the current Wall Street rally. As the Dow Jones industrial average reached 1,037 last week for its highest close in nearly a decade, shares of New York's Citicorp gained 5 7/8 points, to 38%, and Chase Manhattan was up 5 1/2 points, to 54%. Prices of the 24 bank stocks included in an index compiled by the Keefe, Bruyette & Woods investment firm are 46% higher than their summer lows. Despite the outwardly convivial atmosphere, however, an undercurrent of unease ran through the five-day A.B.A. session. Rattled by the rising toll of corporate bankruptcies and the threat of defaults on international loans to such fiscally unstable countries as Mexico and Poland, bankers quietly fear that the worldwide recession has not yet done its worst. Said Mont McMillen, executive vice president of San Francisco's Bank America Corp.: "We're not out of the woods yet. In this environment you keep your muscles taut and ready for the next disaster."

So far this year, 35 banks have failed, more than twice the post-World War II peak of 16 failures in 1976. William Isaac, chairman of the Federal Deposit Insurance Corp., told the A.B.A. gathering that the number of institutions on his agency's watch list of shaky banks had jumped to some 320, from 220 in January. While asserting that most of the banking system is still strong, both Isaac and C.T. Conover,

U.S. Comptroller of the Currency, predicted that more banks will be in trouble next year. Said Conover: "The most serious problems in bank loans lie ahead."

For the moment, though, the officers of many of the biggest U.S. banks were beaming about their third-quarter profit performances. Citicorp reported a July-September operating income of $210 million, a 56% gain over the same period a year ago. San Francisco's Wells Fargo Bank scored a 38% earnings rise for the quarter, and at Pittsburgh's Mellon Bank profits were up 35%. Even Chase Manhattan, which lost $16 million in the second quarter, managed to post earnings of $124 million, 7% higher than a year ago.

Profits have improved in large part because the plunge in interest rates has made it much cheaper for banks to obtain new funds. The going rate they must pay for three-month deposits of $1 million or more, for example, has dropped from 15.3% at the end of June to 9% now. But the banks have lowered more slowly the interest they charge for loans. The prime rate on corporate loans had fallen only from 16.5% to 12% until last Friday,

when New York's Chemical

Bank lowered it to 11.5%. As a result, the spread between what banks pay for money and what they charge for it has widened, and profits have grown accordingly. Spreads have become particularly broad on consumer loans.

Some banks still demand as much as 18% for an auto loan and 21% for home-improvement financing. Bankers defend these high rates on the grounds that much of the profit on relatively small loans to individuals is consumed by high processing costs.

Earnings from the wider interest-rate spreads masked an alarming rise in losses from bad loans. Chase Manhattan wrote off loans of $68 million in the quarter, compared with $24 million in lending losses during the same period a year ago. Citicorp's write-offs were up 84%, to $103 million. At the Bank America Corp., loan losses of $110 million were serious enough to depress overall profits by 14%, to $103 million.

By far the most troubled major bank is Chicago's Continental Illinois. Continental's profits plummeted 52%, to $32 million, because the bank had to write off $181 million in bad loans. The biggest part of the loss was $107 million in loans to oil and gas companies that resulted from Continental's dealings with the failed Penn Square Bank in Oklahoma. Worse, Continental still has on its books a staggering $2 billion in so-called nonperforming loans, on which borrowers have fallen behind on then-payments. That total amounts to nearly 6% of the bank's loan portfolio.

Continental's nonperforming loans include about $70 million to International Harvester, which has been skating on the edge of bankruptcy for months. In total, Harvester owes $4.2 billion to more than 200 banks in the U.S. and abroad. Six

American banks, including First National Bank of Chicago and BankAmerica, hold Harvester loans of $125 million or more. A Harvester bankruptcy would thus generate huge losses. Moreover, bankers nervously wonder how many other major corporations will be in jeopardy if the economy does not pull strongly out of the recession. Says Elvis Mason, chairman of the InterFirst Corp., a bank holding company in Dallas: "It's the bankrupcty I have not yet anticipated that worries me most."

Though concerned about loan losses, most bankers bristle at the suggestion that the stability of the financial system may be in danger. Says Walter Wriston, chairman of Citicorp: "Every major bank in America last year made more money than General Motors, Ford and Chrysler combined. They lost more than $1 billion. But if one bank out of 15,000 loses money for one quarter, it looks like the end of the world to people." Most Washington officials share the bankers' confidence. Says a member of the Federal Reserve Board: "Even the relatively few banks that have been hardest hit have weathered the recession extremely well."

Bankers contend that they are now in better shape than they were in the aftermath of the 1973-75 recession. That downturn cost the banks $10 billion in losses on loans to speculative real estate ventures that went bust. This time around, the banks were more cautious about land deals. Says Willard Butcher, chairman of Chase Manhattan: "We mightn't be the brightest guys in town, but we aren't dumb enough to do it twice."

At most major banks, problem loans represent less than 3% of the total loan portfolio, a seemingly minuscule percentage. Potential losses look more serious when compared with stockholders' equity, which can be thought of as what a bank would have left if it paid off its depositors and creditors. At the moment, Chase Manhattan's nonperforming loans amount to 48% of equity; for Citicorp the ratio is 32%. Though disturbing, these percentages are no worse than those that prevailed during the last banking slump in 1975. At Continental Illinois, however, nonperforming loans of $2 billion represent a stunning 121% of shareholders' equity.

As bad as they are, the banks' problem-loan figures are understated because they do not include many questionable loans to foreign countries. Says Comptroller of the Currency Conover: "For me the most worrisome difference between the last recession and this one is the growth of international lending. Foreign loans by American banks now amount to $320 billion, a total that is 80% more than it was only five years ago." A speaker in Atlanta with firsthand knowledge of many of the new foreign customers was not reassuring. Said former Secretary of State Henry Kissinger from the podium: "In many countries the debts have already become a major political problem. Lending must go on and it must be in excess of interest payments." In other words, banks will have to lend so foreign borrowers can keep paying interest.

While that kind of pyramiding sounds ominous to some, Citicorp's Wriston contends that the chances of default by a major country are "zero." A nation that defaulted, he persuasively argues, would cut itself off from the world monetary system and be unable to finance essential imports. Felix Rohatyn, a partner in New York's Lazard Freres investment banking firm, disagrees. Says he:

"It is an illusion to think that no sovereign country will default on its external debt because it would become a pariah in the international financial community. A repudiation of debt could occur as a result of radical political changes, as is possible in lit erally any Latin American country, or geopolitical decisions, as might be the case in Eastern Europe."

In recent months, bankers have be come more cautious, and the flow of new foreign loans has slowed markedly.

This, as Kissinger suggests, may be as risky as overgenerosity. The banks thus have no easy way out of their bad-loan bind. They can only hope that a robust economic recovery, both in the U.S. and abroad, will revive the fortunes of the legion of hard-pressed debtor companies and countries. -- By Charles Alexander.

Reported by Lee Griggs/ Chicago and Frederick Ungeheuer/New York

With reporting by Lee Griggs, Frederick Ungeheuer

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