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The banking industry's eight-year string of record earnings could be grinding to a halt, thanks in part to large write-offs of problem loans and rising interest rates.
By JEFF HARRINGTON
© St. Petersburg Times, published July 2, 2000
TAMPA -- Ken Coppedge is in a quandary.
As president of Florida operations for Wachovia Corp., Coppedge has the ambitious assignment of growing the North Carolina bank's $1.5-billion in assets in Florida by about 60 percent a year.
Problem is, his timing isn't the best.
Along with a smattering of other large banks, Wachovia in June warned of a shortfall in second-quarter profits. The culprit in each case: bad loans.
Like many bankers, Coppedge thinks Wachovia, long known as a conservative lender, simply was ahead of its peers in reporting problem loans in a gradually deteriorating economy. Like everyone else, he doesn't know how quickly problems elsewhere will materialize or how deep they will run. In the meantime, consumers and businesses are starting to hold back spending as they realize the booming economy may be slowing.
Coppedge still sounds confident of reaching his goals, though he tempers his enthusiasm. "I think there is a heightened level of uncertainty out there," he says.
These are the times that try a banker's fortitude.
Rising interest rates have put a squeeze on the profits banks make off loans. The charge-off rate for underperforming loans is at its highest since 1992. The industry's ratio of reserves to loans is at its lowest since 1987. Office vacancies last year rose for the first time since 1991.
Put it all together and the banking industry's eight-year string of record earnings could well be grinding to a halt.
"All of this is normal when you're talking about the downside to a long growth expansion," said Miami banking analyst Ken Thomas, who compared the cooling economy to football's once-mighty Pittsburgh Steelers. "At some point, everybody's streak has to come to an end."
Of course, the end has been predicted before.
Banks were supposed to see profits fall off in 1999 as the Federal Reserve kept boosting interest rates. Instead, the industry earned a record $71.7-billion on lower expenses and rising non-interest income from fees and brokerage services. In the first quarter of this year, banks posted record earnings of $19.5-billion, up 8.8 percent.
But this time, the warnings appear to be coming true.
Some large institutions, including Wachovia, are taking large write-offs of problem loans. In announcing a $3.8-billion restructuring last week, First Union chief executive Ken Thompson said the Charlotte, N.C., bank wanted to get problem loans off its books "as we allow for the economy to continue to deteriorate."
One reliable bellwether of growing credit risk -- or at least investor wariness of credit risk -- is that the market for bank bonds has slumped to its lowest level in more than five years. That indicates concern that more borrowers will default on bank loans.
Even as investors slowly started to move back into depressed bank stocks in the past few months, the bank bond market continued to fall.
The deteriorating bond market last month prompted two analysts from Credit Suisse First Boston to predict higher problem loans from banks such as Bank of America and Fleet even before news of the first big write-offs were announced.
"Bank bonds haven't looked this bad since the last recession," Credit Suisse analysts Michael Mayo and David Hendler wrote in a recent report.
The Federal Deposit Insurance Corp., which insures bank deposits, has preached for five years about the need to improve the credit quality of loans made by banks. Its mantra goes something like this: Banks have loosened up on their lending criteria after losing some of their traditional deposit base to mutual funds and stocks. Now, they'd better tighten up to avoid problems when consumers can't keep up with rising interest rates.
More recently, FDIC chairman Donna Tanoue applauded banks for tightening lending terms a bit. But it appears some of the damage has been done.
In its second-quarter report, the FDIC said signs of deteriorating credit quality in commercial loans are abundant even though economic conditions remain "extremely favorable." Regulators pointed out three indicators in particular that are heading up: corporate bond defaults, the charge-off rates for bad commercial and industrial loans and the number of bond rating downgrades compared to upgrades.
Nancy Bush, a bank analyst with Prudential Securities, has no doubt the banking story of the year will be a steady increase in non-performing assets, a catchall term for loans on which the bank is not collecting interest.
"What we don't have yet," Bush said, "are two worrisome things on the horizon: consumer credit quality issues and a leading industry, other than health care, where there are a huge number of problem loans out there."
In 1990, bad loans in commercial real estate paved the way for a recession.
Bill West, executive vice president overseeing commercial banking at the Bank of Tampa, said developers and home builders may be moving slower lately but he doesn't think the door of opportunity has closed yet.
"Are we more cautious (with lending criteria) than we were this time last year? Absolutely," he said. "Are we concerned of a pending problem in any sector that we do business in? No."
West also sees one other key element missing in a downturn: a credit crunch. Small and midsize businesses still have plenty of options for securing loans, particularly in a competitive market such as Florida.
"There is so much money in the banking system that needs to find a home," he said. "Any good business opportunity is going to find more than one bank for an audience."
The oft-repeated goal of the Federal Reserve in approving a series of interest rate increases is to negotiate a "soft landing" that gradually slows the economy. In other words, it wants to keep a hypercharged stock market in check without pushing the country into a recession.
By holding off on another rate increase last week, the central bank apparently signaled it thinks its medicine is working.
And so do chief economists at nine of the country's biggest banks. In its semiannual forecast last month, the economic advisory committee of the American Bankers Association predicted that economic growth would slow to 3.3 percent next year with inflation kept under 3 percent.
In their report, released after the Wachovia warning, the economists also said credit quality remains excellent and downplayed the likelihood of a credit crisis.
Some analysts, such as Lawrence Cohn of investment firm Ryan Beck, are equally optimistic. He contends that isolated reports of bad loans are only showing up now because banks have been spoiled by good times.
"The credit quality for the banking industry has been superb the past several years, reflecting the terrific strength in the economy," Cohn said. "It was inevitable that at some point we'd start to return to more normal levels."
He contends Wachovia's problems are specific to Wachovia.
"In that case, what you have is a company that after an eternity of having far better than average credit quality has sort of come down to earth," he said. Because many of Wachovia's old customers have shifted to investing and lending through the capital markets, Cohn said, "they've had to attract new customers who quite frankly aren't of the same quality."
Thomas, the independent analyst in Miami, agreed that "Wachovia is not the same Wachovia we used to see." But then again, the credit quality of many banks has slipped.
So which other banks active in Florida are at risk?
Four Alabama banks with a big presence in Florida -- Regions Financial, Colonial Bancgroup, Compass BancShares and SouthTrust -- and one Tennessee bank, Union Planters, were included on a recent Business Week list of the 10 most vulnerable banks. The list was based on banks that have unusually low loan reserves, a great dependence on loans for income and a higher percentage of non-performing loans.
Banks that have a large non-lending source of income, such as trust giant Northern Trust, generally are more attractive in such an economy. But investors already have bid up many of those stocks even as most bank stocks tumbled.
Investors are divided about prospects for Bank of America, which commands almost a fourth of Florida's deposits. Cohn is bullish because the megabank has such a large, diversified loan portfolio filled with conservative mortgage loans; others, such as Mayo of Credit Suisse, anticipate more problem loans.
The Charlotte bank declined to talk about its loan portfolio or credit quality issues last week. A spokeswoman said the bank did not want to discuss financial information before it releases second-quarter earnings July 17.
The slowdown may be particularly hard on start-up community banks trying to establish a customer base. Typically, new banks take up to three years to turn a profit. The FDIC is telling them the journey may take longer as the economy slows.
Florida has no shortage of start-ups. Many were spawned in the past few years to seek customers disenfranchised when the state's biggest bank, Barnett, was bought by NationsBank (now Bank of America).
To Coppedge, the Florida chief for Wachovia, that spells opportunity. Without being specific, he said some community banks that are having pressures on their loan portfolio are more open to talking about a buyout now than they were a year ago.
It would be one way to help him catch up to his growth targets in Florida.
In May 1999, Coppedge predicted Wachovia would open six branches in the Tampa Bay area within 10 months. Fourteen months later, the bank has opened only one, in downtown Tampa, and has four other locations picked out in Hillsborough County.
It still is looking for its first site in Pinellas County.