Nice aricle on credit quality posted on the Strictly Drilling thread:
smartmoney.com
But if the rumors were so patently false, why did investors pull the trigger on bank stocks? Simple: Wall Street is walking on eggshells these days when it comes to the issue of bad bank loans. Just when it appears that things are under control, another problem flares up. No one knows for sure how bad the trouble is.
After all, it was only a month ago that Bank of America announced it would take a charge against earnings to write off some $1.2 billion in uncollectable loans. This after earlier problems at Wachovia (WB) and First Union (FTU) had already burned the credit-quality issue into investors minds.
The hope, of course, was that the Federal Reserve's surprise interest rate cut on Wednesday would make bank stocks attractive again. Lower interest rates mean banks will be able to boost profits by making more loans — and on more favorable terms. Behind this optimism was the assumption that the fallout from bad bank loans would be relatively limited, since most big institutions began tightening their lending practices after the Asian financial crisis in 1998.
Since it usually takes some time for a loan to go bad, the problems banks are wrestling with now reflect sloppy lending before that clampdown. And the better lending standards banks subsequently adopted mean that their loan portfolios will soon look much better, this thinking goes. "We are all nervous...but the early indicators are that the worst may be over," says Tom Brown, founder of Second Curve Capital, a money-management firm, and a former banking analyst who runs the Web site Bankstocks.com. "In most cases, these were just bad loans...to bad management teams. I'm optimistic that by the summer we will be talking about how the outlook for 2002 is quite bright."
But in the view of the government's big bank regulator, the Office of the Comptroller of the Currency, there may be still more trouble baked into banking's cake. "I don't share the view that the end of this game [of lax lending practices] came in 1998," says David Gibbons, deputy comptroller for credit risk at the OCC. "I didn't see any real tightening until after the first quarter of 2000." It's true, Gibbons says, that banks stiffened their loan standards in the immediate aftermath of the Asian financial crisis — but once it was clear that the nation's economy wasn't headed for financial ruin (thanks in part to some swift rate-cutting by the Fed), they quickly returned to their old ways.
The products that most trouble Gibbons and other industry watchers are leveraged loans, which are arranged by big banks to finance corporate mergers and other major transactions. A leveraged loan is "syndicated," meaning several banks serve as underwriters and sell it to institutional investors, much as happens with junk bonds. The deals not only generate hefty underwriting fees for the banks, but the portion of those loans that remain on the banks' books return much higher rates of interest than traditional financing deals.
Here's the scary part: In the first quarter of 2000, 45% of the $77 billion in leveraged loans arranged by banks was used to finance corporate telecommunication deals, according to Loan Pricing Corp., a debt-tracking service owned by Reuters. Since that time, of course, many of those companies — and their stocks — have fallen on hard times, increasing the chances of default.
Which banks have been most active in this business? In recent years, the likes of J.P. Morgan Chase (JPM) — the newly formed entity arising from the merger of J.P. Morgan and Chase Manhattan — Bank of America, FleetBoston (FBF) and First Union have embraced syndicated loans in a big way, particularly after the junk-bond market started drying up. And there's little evidence that banks have recently tightened up on such loans. Last year, for example, the nation's big commercial banks arranged $300 billion in leveraged loans, just $20 billion less than the record number set in 1999, according to Loan Pricing. J.P Morgan Chase and Bank of America accounted for 45% of the market. |
