Bleak Year For the Banks

By Gordon Bock

In the days of doubt and anxiety following the stock-market crash, U.S. banks got a public vote of confidence as Americans rushed to put more of their money into nice, solid, federally insured savings and checking accounts. That was a far cry from the 1920s and '30s, when frightened investors hustled to their banks and clamored to withdraw their money. But even though angry mobs are rarely battering at their doors, today's banks and thrifts are being rocked by tremors just as dangerous as those of half a century ago.

Bad loans and rising competition are choking the profits of America's 14,300 banks, killing hundreds of small institutions and stunting the growth of larger ones. Earlier this month federal regulators closed nine insolvent banks in a single day; during all of 1987 they expect to shut down nearly 200, a post-Depression record. Says L. William Seidman, chairman of the Federal Deposit Insurance Corporation (FDIC): "The banking industry will have its worst year since 1934."

The shaky side of the balance sheet for today's banks is not necessarily deposits but loans. The U.S. banking industry is saddled with $59 billion worth of sour loans made to a lengthening list of troubled borrowers: developing countries, farmers, takeover artists, real estate developers, oil drillers and spendthrift consumers. While most U.S. banks can handle bad debts during good times, a recession would turn a quiet problem into a grinding one. Many more borrowers could go over the brink, along with their banks. The resulting rash of federal bailouts could strain the Government's deposit- insurance system and even turn depositors' nightmares into reality.

To prepare for that rainy day, America's banks are facing the painful task of giving up on their most hopeless loans, taking the losses now rather than putting them off. Last week Bank of Boston, the 13th largest U.S. bank, said it plans to write off $200 million of its total $1 billion in Third World loans and set aside $470 million to pay for losses it might sustain on the rest. While other banks, led by New York's Citicorp, announced huge set-asides earlier this year to cover losses on Latin debt, the Boston bank's move was the first time that a major lender had given up on such loans. The radical decision puts pressure on other banks to make similar admissions. That would be costly. If Citicorp were to cover its developing-country loans to the same extent, it would have to set aside an additional $4.1 billion, or more than four years of profits.

Already, the limited coming-to-grips with bad loans has wiped out 1987 profits at many major U.S. banks. Analysts expect most of the largest institutions to post overall losses. Among them: Citicorp, BankAmerica, Chase Manhattan, Manufacturers Hanover and Chemical Bank. Last week Pittsburgh's troubled Mellon Bank, the twelfth-ranking U.S. institution, disclosed that it would be about $220 million in the red for the fourth quarter, after boosting its loan-loss reserves.

The dose of reality comes just in time, for Latin debtors are less able -- or willing -- than ever to make their payments. Brazil (total foreign debt: $113 billion) has refused since February to pay interest on its bank loans, though the government has said it plans to resume some payments within the next few weeks. The promise may be shaken by the resignation last week of Brazilian Finance Minister Luiz Carlos Bresser Pereira, who negotiated the payback idea. In Mexico ($105 billion) a collapse of the stock market has triggered a financial crisis. Inflation has roared to nearly 150% a year, while the peso has plummeted. Last week the Mexican government officially devalued the peso 22%, making repayment of dollar-denominated loans more difficult for Mexican borrowers.

For the most part, developing-country debts afflict America's big-city banks, but other institutions have plenty of sour loans of their own. Plunging petroleum prices will bring more gloom to banks in the oil patch, where foreclosures and bank failures have become as common as barbed wire. Of the five bank holding companies that were Texas' biggest in 1984, only one (MCorp) remains independent, following a string of mergers with healthier banks. Smaller oil-patch institutions have simply collapsed. On a recent afternoon in a vast yellow warehouse outside Midland, Texas, the FDIC auctioned off the repossessed assets of 24 failed state banks, including oil-rig gear, Rolex watches and a 1985 Jaguar that had been used as collateral.

The newest sheaf of bad paper is coming from real estate developers, particularly those in the Sunbelt, who built a huge overabundance of office towers, hotels and condominiums. Vacant office space amounts to an estimated 22% of the available square footage in Houston, 33% in Oklahoma City, 30% in Denver and Fort Lauderdale. A separate, over-the-horizon problem for banks could stem from their financing of corporate leveraged buyouts, in which managers borrow to the hilt to take over companies that are typically weak or vulnerable.

Banks have made shaky loans because their original blue-chip borrowers, major corporations, now often get their money elsewhere. In the past, banks could corner the lending business because they were the only financial institutions with access to credit information about borrowers. But through computers and data banks, that information is today widely available to any investor who wants to lend money. Thus major corporations can borrow by issuing so-called commercial paper, or corporate IOUS, which investment banks underwrite and trade for their corporate clients. At the same time, banks face a rising tide of competition from foreign institutions, especially aggressive Japanese lenders. In just a decade, foreign banks have increased their U.S. commercial and industrial lending from $17 billion to $91 billion. Discussing the growing competition, Daniel Davison, chairman of U.S. Trust, a small, upper-crust Manhattan bank, growls, "My views can be summed up in one word: dismal."

Not all banks are hurting. Many regional banks like North Carolina's Wachovia and conservative institutions like Manhattan's Morgan Guaranty Trust are in relatively fine shape. But overall, the industry's profits are shrinking. A key ratio -- profits as a percentage of total holdings, or return on assets -- has dropped to a minuscule .02%, below the .7% average that prevailed earlier in the 1980s.

Troubled as life is for U.S. banks, savings and loan institutions have it worse. The 3,200 thrifts overseen by the Federal Home Loan Bank Board lost $1.6 billion in the third quarter, more than 40 times the $35 million deficit they posted in that period last year. The one consolation is that the problems are concentrated; more than 60% of this year's losses came from Texas.

The upheaval in banking has produced relatively few shivers among depositors, because they know their money is backed by the Government up to $100,000. So far the FDIC has managed to cope with its huge string of bank closings, ending the year with about $18 billion in assets, or roughly as much as it had a year ago. The FDIC paid out a record $3.5 billion in 1987, which was matched by the insurance premiums that member banks pay, plus interest on the agency's holdings. But the Federal Savings and Loan Insurance Corporation, which backs deposits in thrift institutions, is not faring so well. Last summer Congress authorized the agency to raise an emergency $10.8 billion in recapitalization, but the FSLIC's reserves of $2.7 billion are dwarfed by the $40 billion or so that would be needed to bail out all the shaky thrifts.

Do banks have a strong future? Many banking leaders think their institutions can survive only if they are allowed to expand into other financial services, most notably investment banking. While it seems an inopportune time for banks to enter territory where Wall Street firms are retrenching, support is growing in Congress for a revision of the 1933 Glass-Steagall law, which prohibits banks from underwriting securities. Wisconsin's William Proxmire, chairman of the Senate Banking Committee, hopes to lead passage of a new banking law by March. His counterpart in the House, Rhode Island's Fernand St Germain, who in the past has opposed the liberalization of banking laws, has reportedly ordered his staff to draft a bill that would give banks broad powers in securities, real estate and insurance.

For the moment, banks are scrambling to become leaner and more competitive. Citicorp, Chase, Chemical and Mellon this year slashed a total of 5,800 jobs. At the same time, many banks are raising fees for their services, including even automatic-teller withdrawals. Such moves may be painful, but they could ensure that U.S. banking does not become a money-losing proposition.

With reporting by Richard Hornik/Washington and Wayne Svoboda/New York