A key element in the whole bubble and breakdown in the market:
Banks Find Linking of Loans
To Other Business Has Perils
By JATHON SAPSFORD and PAUL BECKETT
Staff Reporters of THE WALL STREET JOURNAL
NEW YORK -- A few years ago, J.P. Morgan Chase & Co. poured money into the telecommunications and cable businesses. Though the bank didn't expect to make much money on the loans themselves, it anticipated a huge payback from investment-banking business the companies would send its way in exchange for the credit.
The payback came this week -- in the form of $1.4 billion in costs related to souring loans.
TIP OF THE ICEBERG?
• J.P. Morgan's Loan Problems
Could Spread to Other Banks
J.P. Morgan's hit, which sent the company's shares down more than 7% Wednesday, was the result of a string of dud loans made by the bank to telecommunications and cable companies -- often as part of a quid pro quo arrangement in which the companies also agreed to send their high-fee investment banking business J.P. Morgan's way.
It is one of the more controversial features of the current banking age: As J.P. Morgan and its main rivals, Citigroup Inc. and Bank of America Corp., continue to bulk up, they increasingly are using their enormous lending prowess as an incentive to win other business -- sort of like a bar that sets out free chips and then charges $8 a beer.
When the economy is doing well, the arrangement can be good for banks and their customers alike. The banks don't make much money on the loans themselves but get the chance to steal high-margin investment-banking business from traditional Wall Street powerhouses such as Goldman Sachs Group Inc. and Merrill Lynch & Co. And the customers get plenty of access to credit.
But when things sour -- and particularly when entire sectors such as telecommunications start to swoon -- the nation's biggest banks can find themselves holding hundreds of millions of dollars in loans, big chunks of which they probably wouldn't have made if there also weren't a promise of other business down the road.
The outcome of the strategy has turned out to be the opposite of what the banks had hoped: Instead of boosting their bottom lines and making them more formidable competitors, the practice is hampering their profits and giving ammunition to critics who now are calling for new barriers to separate banks' lending and investment-banking businesses.
Some companies say the banks have been none too subtle in saying that loans will only be forthcoming if they get investment-banking business in return. "It's very clear," says David Hauser, vice president and treasurer at Duke Energy Corp. In exchange for bankers' providing loans, "there is clearly an expectation on their part of other business."
Bankers counter that the lending business, on its own, isn't very lucrative and needs to be part of a broader relationship in which loans are effectively subsidized by other business that generates more money for the banks. They add that clients themselves often demand loans in exchange for doling out investment-banking prizes. The banks also note that there are investment-banking clients to whom they haven't extended credit.
"We strongly believe that this model is an end-game winner and is what our clients prefer," a J.P. Morgan spokeswoman said. "No one is critical of Bloomingdale's for selling both clothes and furniture."
In J.P. Morgan's case, nearly all of the telecom companies at the center of this week's bad-loan warning became clients, insiders say, in part because of the promise of later investment-banking deals.
The bank, for instance, two years ago was the lead lender, along with several other banks, in a $2 billion credit line for Genuity Inc., an Internet company spun off by Verizon Communications Corp. J.P. Morgan's share of that credit line was $500 million, people familiar with the matter say.
A year later, in September 2001, J.P. Morgan received a lucrative mandate to underwrite $1.5 billion in bonds for the company. J.P. Morgan said it wouldn't comment on any specific client. Genuity declined to comment.
In Default
Now, Genuity is in default on the $2 billion in loans. And while J.P. Morgan didn't disclose the names of the borrowers whose loans it was forced to write down this week, officials familiar with the matter say Genuity was one of the biggest problems on a long list of struggling customers. J.P. Morgan has also lent money to other prominent companies in the battered telecom sector, including Qwest Communications International Inc., MobilCom AG, Lucent Technologies Inc. and Motorola Inc. Motorola, Lucent and Qwest declined to comment. MobilCom wasn't immediately available for comment.
Despite the writedowns, loan-loss levels at J.P. Morgan and the other big banks, while rising, still are far below levels seen in past recessions. That's partly because the banks have been very savvy about parceling out pieces of the loans to other banks and investors, keeping less of the risk on their own books.
Indeed, the biggest threat to the banks from the writedowns isn't to their solvency but to their earnings, as they may be forced to set aside profit as provisions against bad loans.
Senior J.P. Morgan executives say that most of the loans the bank will now write down this quarter are to borrowers who are in trouble but still viable. But at least some of those borrowers are expected to go under. As they do, J.P. Morgan will likely have to write down its loan portfolio further, generating more losses.
"They are by far the biggest player in telecom," says Andy Collins, an analyst at U.S. Bancorp Piper Jaffray. "We still could have more risks out there."
At the end of last month, Moody's Investors Service placed the long-term debt of J.P. Morgan on credit watch for a possible downgrade, in part because its strategy of using commercial-banking relationships to boost investment banking has met "mixed success so far." On Tuesday, Standard & Poor's Ratings Services and Fitch Ratings downgraded J.P. Morgan's debt.
A major concern for analysts is whether the banks have compromised their lending standards in order to win investment-banking business.
In April, Nortel Networks Corp. received a $1.2 billion revolving credit line from J.P. Morgan, Citigroup and others.
In June, Citigroup and J.P. Morgan, both longtime lenders and investment bankers to the company, were two of the banks given prominent roles on a Nortel equity issue. Both banks reaped millions of dollars in fees.
When the loan was made back in April, "the sentiment in the loan market was that the price Nortel and its chief lenders settled on did not reflect the risk that might be in the credit," says Faris Khan of Loan Pricing Corp., which tracks the loan market.
Bankers involved in the Nortel loan acknowledge that it was given at below the then-market price. But they say that was justified because the credit line wasn't new money but replaced an existing credit line that was on even cheaper terms. All 24 banks that held pieces of the existing credit line signed off on the price of the replacement.
They add that there was no explicit linkage between the loan and the equity issuance, but one said Nortel was rewarding its "friends" with "collateral business." Spokesmen for Citigroup and J.P. Morgan declined to comment.
Linking loans to investment-banking business has long been a controversial topic, largely because of the power that it can give lenders. More than 30 years ago, Congress made it illegal to condition bank loans on the receipt of other business -- a practice known as tying. But there is an easy way for banks to circumvent the law.
For a tying violation, the loan has to be booked directly through a banking unit. If it is booked through a securities unit or a holding company -- as is done routinely at the big banks -- there is no violation, even if the loan is expressly conditioned on receiving other business. For that reason, investment banks are free to link loans to underwriting business. Moreover, the antitying law doesn't apply to banks' business with non-U.S. companies. Nortel, for instance, is Canadian." |
