WORRY AT THE WORLD S BANKS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84B00049R001102640014-1
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 5
• Document Creation Date: December 22, 2016
• Document Release Date: March 15, 2007
• Sequence Number: 14
• Publication Date: September 6, 1982
• Content Type: OPEN

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Qf%,YNEY & BANKING
The world's financial system is facing its
greatest test of strength in decades.
And even though the plunge in interest
h rates will bring relief to some borrow-
;' era, scores of others, from corporations
to governments, are becoming delin-
quent debtors overnight, threatening the
profitability of individual banks and the
liquidity of the entire financial system.
Y 'Already battered by problems ranging
from Penn Square to Poland, creditors
are rushing to save Mexico by reschedul-
ing debt and extending fresh credit on a
scale never before attempted. "The one
thing we know is that things are going
to get worse before they get bete -
ter," says Alexandre Lamfalussy,
chief economist and assistant man-
sger for the Bank of International
Settlements in Basel, Switzerland.
Bankers are bracing themselves for
a rescheduling of Argentina's $24.8
billion bank debt, and Peru is likely
to go to international bankers for a
second rescheduling of $4.4 billion
in bank debt. -
Mexico--of strategic importance
Horne, European economist for Smith
Barney Harris Upham Inc. The greatest
threat to the financial system, bankers
concede, is from depositors and institu-
tional investors who might suddenly de-
cide that yanking money out of a num-
ber of banks would be prudent-and for
them, it might be, but it could precipitate
a widespread liquidity crisis. "The worst
thing that could happen is for major in-
stitutions to find their funding opportu-
nities severely constrained by a market
so obsessed by a flight to quality that it
refuses to lend to these institutions,"
warns one U. S. bank economist. "We're
but several banks have been stung. Con-
tinental Illinois National Bank & Trust
Co., caught in the Penn Square tangle
with $1 billion in energy loans it had
bought from the failed Oklahoma City-
bank, is paying a premium for pur-
chased funds. And markets were
shocked by the losses Chase Manhattan
Bank had to swallow in the wake of
Drysdale Government Securities Inc.'s
failure to pay its debts. The aftertax
cost to Chase of covering Drysdale's ob-
ligations to securities firms was $117
million, and it posted a $16.1 million loss
as a result during the second quarter.
German banks, already badly ex-
posed to problems in the East bloc
Problem loans pile up
Growth instead of judgment.
OPEC's surpluses disappear
to the U. S. and because its oil ranks it
_ as a major economic power despite its
recent fall from financial grace-will be
permitted to delay principal payments on
a portion of its debt. And a financial
.package combining bridge loans and
new money will be offered by central
banks, the International Monetary Fund,
the U. S. government, and commercial
-..;banks. The total value of the package
-could reach $10 billion. "Mexico is not
Poland," stresses one U. S. Treasury
Dept. official. "They face an illiquidity
problem, but they will be able to resume
payment on their debt." -
Some 115 senior executives from inter-
national banks heard out the country's
Finance Secretary Jesus Silva Herzog,
at a hastily called meeting in New York
on Aug. 20, and a 14-bank steering com-
mittee was quickly formed to set the
-.terms of a new bank loan. But however
swift the accommodation of that trou-
bled economy's needs, it will not mark
the end of bankers' woes.
Bankers are worried not only about
the actual loan losses banks will suffer,
but also about market perceptions of
bank problems. The problems are "con-
sidered by most market participants as
systemic or endemic," says J. Paul
not in that case yet, but there's a poten-
tial confidence problem. There'll be no
systemic problem as long as the flight to
quality doesn't get out of hand."
So far, institutional runs have oc-
curred only on a limited basis. A small
Texas bank, Abilene National Bank, be-
set by rumors that its energy portfolio
was troubled, suffered such a run fol-
lowing the failure of Penn Square Bank.
The Federal Reserve, acting as lender of
last resort, advanced money to the bank,
but the institution was finally merged
into a larger bank holding company in
Texas. In Europe, where the collapse of
Italy's Banco Ambrosiano sent shock
waves through the financial system,
creditors of the bank's Luxembourg sub-
sidiary suddenly found themselves un-
protected by central bank guarantees
they had assumed were there all along.
Tiering the banks
These incidents have turned markets
skittish, and a handful of corporations
with spare cash are reportedly shunning
bank certificates of deposit and commer-
cial paper as investments. A genuine li-
quidity crisis necessitating speedy reac-
tion by central bankers has not occurred,
and faltering domestic corporations
such as AEG-Telefunken, recently
found their Luxembourg subsidiar-
ies straining to raise funds after the
Ambrosiano failure.
Worldwide, a "tiering" of bank
names is taking hold,_ with some
banks paying more for borrowed
money than others. And in an inter-
bank market where 1,000 partici-
pants-up from nearly 200 a decade
ago-borrow and lend funds on a shorty'
term basis, even the rumor of trouble
can shut a bank borrower out. Bankers
concede they cannot be sure of their ex-
posure in the. interbank market because
a single loan, to one bank ,j*nay go,
through a series of borrowers and for-
eign exchange conversions.
'9hen Mexico's financial troubles ex-
ploded in mid-August, the markets were
prepared to believe that major U. S.
banks would lose millions on loans made
south of the border. In this panicky at-
mosphere, rumors outran facts.' At one
point; the spread between three-month
U. S. Treasury bills-deemed a safe in-
vestment-and commercial bank CDg
widened to 300 basis points, or three
percentage points, double what it had
been days earlier. 't'he markets aren't
necessarily adjusting appropriately or
logically," says one bank economist:
The dramatic reversal in Mexico's for-
tunes strikingly demonstrates the chain
of events that has transformed once-
worthy borrowers into sickly debtors.
Driven by the inflationary fervor of the
late 1970s and brimming with deposits
from OPEC, banks extended everincreas-
ing amounts to hungry corporate and
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sovereign borrowers. Commodity prices the debt pie declined. By 1982 commer-
spiraled, oil seemed as good as gold, real
borrowing costs were negligible, and the
dollar was weak. Borrowers were con-
vinced they could pay loans back in
cheaper dollars. "The banking system
can't be divorced from the world eco-
nomic system," says David F. Lomax,
group economic advisor at National
Westminster Bank in London. "The
OPEC situation led to an aberration, a
permissive attitude to borrowing. That
couldn't go on forever, and that is
what's happening. We're seeing the
withdrawal symptoms."
From 1973 to 1981, long-term debt of
less developed countries (LDCs) surged
from $97.3 billion to $4252 billion (chart),
an average annual growth rate of 20%.
Debt owed by the East bloc alone soared
from $7.9 billion to an estimated $80 bil-
lion during the same period. And al-
though government and supranational
agencies such as the IMF and the World
Bank played a part in recycling surplus
dollars f-som OPEC to LDCS, their share of
cial banks in the West held $327 billion,
or 65%, of total LDC and East Bloc debt,
up from 45% a decade earlier.
But the world turned upside down for
third-world borrowers when, in an effort
to halt the inflationary spiral in the U. S.
and strengthen the dollar overseas, the
Federal Reserve System in October,
1979, began managing the money supply
rather than " targeting interest rates.
Real interest rates-those adjusted for
inflation-had averaged only 0.85% from
1973 to 1980, rocketed to 10.68% in 1981,
.and averaged 16.1% in the first half of
this year.
Each percentage point rise in the Lon-
don interbank offered rate-the rate to
which most loans to governments are
tied-translated into an annual increase
in debt service of $350 million each for
the largest government debtors, Mexico
and Brazil. _
. While borrowing costs climbed, the
price and volume of commodity exports
fell, and global recession dampened de-
mand for third world goods and services.
The impact on growth rates was severe:
The rise in Latin America's gross domes-
tic product, for instance, fell from 5.8%
in 1980 to 1.2% in 1981. .
Worse yet, LDC borrowers were forced
into borrowing short term by banks that
had soured on granting riskier medium-
and long-term debt. The tendency be-
came so widespread that by yearend
1981 fully 49% of Mexico's $57 billion in
bank debt was coming due within one
year. In 1982, Argentina must repay or
refinance 47% of its bank debt, while
South Korea, Chile, Venezuela, and the
Philippines face similar pressures. Con-
sidered less risky than term debt, short-
maturity loans are generally cheaper
and easier for borrowers to obtain, since
a wide variety of institutions-including
credit unions, insurance companies, and
investment firms-are willing to extend
such credit. But these institutions are-
also the quickest to run at the first sign
of trouble. "I worry about how every
thing now is so short," complains the..
BUSINESS WEEK: September 6, 1982 81
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executive vice-presiaenc of a major U. S.
'bank. "Everything in the whole damn
world comes due between now and next
Tuesday."
The high cost of cash and the clobber.
ing of commodity prices have also hit
the major oil producers. With the OPEC
surplus projected to fall from about $60
billion in 1981 to near zero this year,
several OPEC nations -themselves will
have to borrow in world credit markets.
Their new presence could easily crowd
out some LDc borrowers and possibly
put upward pressure on interest rates.
And while the decline in oil prices would
be expected to benefit nonoil-producing
developing countries, some fear that the
relief will be minimal. A study by econo-
mist William R. Cline of the Institute for
International Economics in Washington
asserts that "for each $1 billion reduc-
tion in the OPEC surplus, the deficit of
nonoil developing countries 'declines by
only $140 million, or 14%."
Some bankers worry that the medicine
used to bring the fever down-a heavy
dose of monetary restraint-may have
been too strong. "You get to the stage
where the additional impact of monetar-
ism gives you smaller and smaller re-
turns in terms of reduction in inflation
at a bigger and bigger cost in terms of
the level of unemployment and the dislo-
cation in the industrial and financial sys-
tem," says Harry Taylor, president of
Manufacturers Hanover Cori).
Corporate casualties
International bankers leave the New York Fed after a hastily called meeting, where
they listened to Mexico's finance secretary plead for debt relief and new cash.
Corporations, bankers point out, have
a "bankruptcy option" that countries
cannot afford. Says one U. S. bank econ-
omist: "The portfolio weighted toward
foreign sovereign debt is far more ee-
cure than one weighted to private sector
debt. A borrowing country cannot refuse
to service its debt. It would be black-
balled from the system."
Problem loans to corporations are
largely responsible for the swelling of
loan loss reserves and "nonperforming"
loans at U. S. banks. And while lower
...rates will mitigate financial strains for
s -411b
some corporations
othe
bl
,
r
e una
e
The turnaround in economic conditions to recover from months of poor sales
worldwide has whipsawed corporations and pitiful cash flow. Furthermore, cor-
just as surely as it has devastated na- porate casualties lag behind recessions,
tion-states. Until recently, the after-in- and bankers expect problem loans to
flation and after-tax benefits of short- continue to climb in coming months.
term bank borrowing, especially in the Evaluating the quality of loan portfo-
U. S., encouraged companies to flock to lios and determining the size of loss re-
the banks, rather than raise long-term serves needed to cover problem loans
debt at high fixed rates. By the time will be the "hardest, most complex, and
declining inflation had pushed real rates 'challenging task" confronting the bank-
of int
t t
eres
o record levels, corporate
borrowers were caught in a vicious cir-
cle. In order to pay off bank loans, they
had to borrow still more money.
The consequences of this squeeze are
now becoming apparent. Such corporate
giants as Germany's AEG-Telefunken,
Mexico's Grupo Industrial Alfa, and In-
ternational Harvester in the U. S. are
struggling under a mountain of debt and
asking their bankers for relief. Numer-
ous other smaller companies are throw-
ing in the towel, filing for reorganization
and protection from creditors under
bankruptcy laws. Corporate bankrupt
cies and reschedulings promise to put a
far deeper dent in bank earnings than do
sovereign debt problems. "Compared
with what the French steel industry
owes us, Polish debt is a minor prob-
lem," says an official at a French bank
ing industry in coming months, says
Thomas H. Asson, chairman of the bank-
ing group at Coopers & Lybrand. Man-
agement response to problem loans is
"very judgmental," Asson says. "You
can put 100 people in a room with 100
different portfolios, and they can come
up with 100 different ways of dealing
with the same credits."
This variability is ultimately reflected
in bank earnings. Because banks are in'
the business of assuming credit risks,
they constantly maintain a cushion,
known as a loar, loss reserve, to cover
potential losses. Additions to the reserve
are deducted from earnings, so they
have a critical bottom-line effect. As of
June 30, the aggregate reserve level for
35 major U. S. banking companies had
surged to $6.1 billion, or 1.02% of total
loans, according to Salomon Bros. Inc.
More nonperformers
C
0
Only a tiny portion of this reserve was
ali,;cated to cover possible losses on sov-
ereign lending. Loans to countries have
been viewed as "evergreen" because of
continuous rollovers and government re-
luctance to take the "bankruptcy op-
tion." Regulators have looked the other
way,' but now they. are considering a
tougher stance (page 83) that would
mandate reserve allocations against re-
scheduled sovereign debt. Even if a
Mexican rescheduling is successfully ac-
complished, concedes one Texas banker,
"anyone who thinks the risks aren't
there for write-offs is kidding himself."
The biggest risks, of course, still he in
the corporate sector, and portions of
Grupo Alfa's $2.2 billion in bank debt
are reportedly already being reserved
against possible loss by some banks.
For those institutions with heavy ex- -
posure to Mexico (table), a rescheduling
MONEY & BANKING
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agreement that postpones principal pay-
ments but keeps interest payments cur-
rent will spare a huge addition to non-
performing loans. The reason is that
nonperformers fxe loans on which inter-
est payments are in arrears,-usually by
60 days or more, loans that have been
restructured with a lower interest rate,
and foreclosed real estate-
Increases in the nonperforming list
are the best.-indication of trouble spots
in a bank's loan portfolio. As of midyear,
these problem loans at the 35 bank hold-
ing companies that Salomon Bros. fol-
lows amounted to $14.7 billion. Bank
stock- specialists at Keefe, Bruyette &
Woods Inc_ find that the nonperforming
loans for 24 top banking companies
amounted to 2.58% of total loans and
foreclosed real estate. While on the rise,
this figure is nonetheless well below the
record 4.9% logged by the banks a fe?.;
' years ago. -
Unsold condominiums
Among the newest additions to the
nonperforming lists at banks are energy
and real estate loans. Inflationary expec-
tations propelled banks to leap into these
lending areas, but lower oil prices, mo-
derating inflation, and high interest
rates have rendered rauntless drilling
projects and condominium developments
uneconomical. Energy equipment manu-
facturers such as Nucorp Energy Inc.
and TOS Industries Inc. have filed for
protection from creditors under bank-
ruptcy law. Continental Illinois, strug-
gling under the weight of $1.3 billion in
problem loans, is owed $188 million by
these two companies alone. The bank
has also reserved against, and put on its
nonperforming list, a portion of the $1
billion in energy-related loans it pur-
chased from Penn Square.
Crocker National Bank's nonperform-
ers will rise $32.7 million as a result of
the Tos bankruptcy filing. In a lending
specialty where the,ability to predict the
future value of oil reserves is- critical,
too many bankers, says Philadelphia Na-
tional Corp. President Richard S. Raven-
scroft, "sure as hell weren't watching
the downside." .
In Florida and California, thousands
of condominium units have gone unsold
and developers are in arrears to banks
that financed the developments. In Cali-
fornia, where 60% of all recent housing
starts have been for multi-unit develop-
ments, there is an inventory overhang of
some 50,000 new and unsold homes. San
Francisco-based Bank of America is
tracking 2,500 new units as "critical"
and has already foreclosed on .550 units.
BofA may try to unload .50 condo units
in Southern California within the next 60
,days by holding an auction.
Despite the real-estate problems,
BUSINESS WEEK: September 6. 1982 63
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bankers insist that their difficulties are
different and Jess severe than in 1975-76
following the collapse of real-estate in-
vestment trusts. Says Joseph J. Pinola,
chairman of First Interstate Bancorp,
which has two-thirds of its $876 million
in nonperformers in real-estate-related
loans: "I'd rather have nonperforming
loans collateralized by California real es-
tate than some of the bad loans of East-
ern banks." -
The fallout from lending for real-es-
tate ventures that have turned sour is
not limited to U. S. banks. Canadian
banks lent heavily to developers active
in the U. S., and some of those develop-
ers are now in serious trouble. Vancou-
ver-based Daon Development Corp. re-
cently suspended interest payments on
its debentures and is furiously trying to
get bankers to reschedule $1.9 billion in
debt. And Canadian banks face myriad
problems domestically, where nonper-
forming loans, at $5 billion, are already
four times greater than last year. Be-
sides real estate, the trouble spots- in-
clude the energy, mining, forestry, , and
fishing industries.
Eyeballing new customers
Britain's Barclays Bank suffered a
second-quarter drop in earnings because
of loans made by its U. S. operation to
troubled corporations here. Dresdner
Bank and other German banks are owed
$1.6 billion by AEG-Telefunken and hold
nearly 60% of the insolvent company's
stock. And Belgium's third-largest bank,
Kredietbank, is owed $210 million by a
Saudi Arabian money exchange-opera-
tion that went bust a month ago.
European banks have been forced to
ante up embarrassingly large reserves
to provide a cushion against losses.
Around the world, major banks have
been reporting lower earnings, and an
international investment commu-
nity worried about the possibility
of large write-offs is. chipping,
away at bank stock values. De-
clining interest rates and the
chance for banks to profit from
sizable lending spreads over the
near term may offset loan losses
to some degree, but it is still an
)J}ljf!///
rlliillti~llL SL.It Ye
Citicorp's Theobald: "No statistical
evidence" that the system is in crisis.
follow the credits more closely," says
one executive at a major Texas bank.
On the international lending side,
bankers concede that they have not paid
sufficient heed to country-risk analysts
who warned of heavy concentrations in
certain areas: Now bankers, especially in
the U. S., are looking toward what they
hope will be greener pastures. For in-
stance, lending spreads on local currency
loans to prosperous Asian corporations
can be especially lucrative and consis-
tently reward international bankers with
profits exceeding the paltry returns they
can earn by buying a piece of a- sover-
eign debt syndication.
For all their difficulties, though,-bank-
ers insist that the international financial
system is resilient and that a major cri-
sis will be averted, provided public confi-
dence is sustained. "The market is react-
ing as though these are the last signals
were a modest $52 million during the
first half of the year, or 0.18% of its
average commercial loans outstanding.
Says Theobald of Mexico's current dif-
ficulties: "It's not a near-crisis point of
unprecedented dimensions that's been
visited on the financial system. There
isn't any statistical evidence to say we're
in a period of mom pressure and more
strain than, At any other time."
Theobald is not alone. Manufacturers
Hanover's Taylor.contends that the re-
cent spate of reschedulings has not dam-
aged bank earnings but could improve
them. "These countries, by and large,
have been able to cope with meeting
their interest payments," Taylor says,
adding: "In fact, to the extent to which
these events have broadened spreads,
they're going to have a beneficial effect
upon bank earnings."
How many skeletons?
Bankers point . out that individual
banks fail every year and that while
many people thought the failure of West
Germany's Herstatt Bank in 1974 was a
catastrophe, the system did not collapse.
"There are hundreds of thousands of
decisionmakers acting as lenders, deposi-
tors, and borrowers," says Theobald.
"No single event transmits itself to the
marketplace. Mexico is not going to dis-
appear, just like California is not going
to disappear." The safeguards, Theobald
and others contend, lie in the very diver-
sity of the system.
Bankers also assert that measuring
whether a borrower can repay all of the
principal owed is an unfair way of judg-
ing the borrower's economic state or, for
that matter,. the bank's prudence in
granting the loan in the first place. They
note that such worthy borrowers as the
U. S. government .and American- Tele-
phone & Telegraph Co. are not expected
ever to repay their. entire debt,
yet lenders continue.-'to extend
money to them. - .
Whatever strains the system is
suffering, the biggest comfort to
bankers and borrowers alike is
the plunge in interest rates. Only
if lower rates are sustained will
the debt-service load on sover-
With, their bankruptcy option, .
.it's_ companies --more than
countries--that -vex the banks
inauspicious time for banks to acquire-
much-needed capital through the sale of
new equity. .
Already there is talk of retrenchment
and re-evaluation of lending practices,
especially in those areas where banks
have gotten caught. Texas banks, with
long experience in energy lending and
still relatively unscathed energy portfo-
lios, nonetheless are scrutinizing pro-
spective customers in the oil and gas
industry more carefully. "We've told our
loan officers they've got to watch the
quality of receivables, debt levels, and
before collapse," contends Bank of
America Executive Vice-President Rich-
ard Puz. "The news is not good, but the
banks are strong."
Indeed, Citicorp Vice-Chairman Thom-
as C. Theobald points out that while Citi-
corp's assets have grown at a compound
annual rate of 5% during the past 2Yz
years,- its international loans have ex-
panded at only a 1% rate. The bank.hold-
ing company's equity capital has grown
at a 9.3% rate in the same period. Mean-
while, Citicorp's actual losses on com-
mercial loans outstanding worldwide
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eign and corporate borrowers lighten,
world economies recover; and I.DC ex-
ports revive. Meanwhile bankers will
have to suffer the suspenseful and
wrenching experience of rescheduling
debts, foreclosing on properties, and
swallowing losses of both money and
pride. While many bankers believe relief
is in sight, observers are not so san-
guine. Having seen a host of problems,
both expected and unexpected, hit the
banks recently, they wonder, as Home
of Smith Barney does: "How many live
skeletons are there in the cupboard?" ^