Continental Bank’s trip to hell and back

Press, 26 May 1984, Page 23

Continental Bank’s trip to hell and back

Reprinted, from the “Economist”

America’s eighth biggest bank, Continental Illinois, has just been to hell and back. It went there when rumours spread this month that its pile of bad loans had finally become too big for it to handle; it returned after a whip round by 16 of its biggest competitors raised SUS4.S billion. First Chicago, Continental Illinois’s neighbour and rival, was among the 16. It

could afford a wry smile about just how fast the banking tables can turn. Only four years ago, after a decade of solid profits growth, Continental’s reputation put its rival in the shade. Continental was the gentleman’s bank of the Mid-West, with ambitions to become America’s biggest industrial lender. The First Chicago was then still embarrassed by the loans it made to Mr Bert Lance, the Budget director in the Carter Administration and to the Hunt family of Texas to finance its silver speculation. Customers were deserting to Continental, and the First Chicago's profits were squeezed. All of this culminated in the departure of Mr Robert Abboud, First Chicago’s autocratic chairman. Now the boot is on the bank. Continental’s chairman, Mr Roger Anderson, left last month after a squabble over the bank’s energy loans. In February, Continental was obliged to sell its credit card business for SUSI76M to the Chemical Bank to make sure it could maintain its dividend. Today, the First Chicago, under its chairman, Mr Barry Sullivan, whom it pinched from New York’s Chase Manhattan four years

ago, is making all the running in the Windy City. With the benefit of hindsight, most of Continental’s problems are traceable to its indiscriminate scramble for growth in the late 19705. It may be that the First Chicago avoided doing the same only because it took a tumble in a similar dash for expansion five years earlier. In the late 19705. Mr Anderson, Continental’s (now ex-) chairman, set the bank on course to become America’s biggest lender to industrial and commercial companies. Continental’s lending officers earned fat bonuses geared to the volume of loans they pushed through. From 1978 to 1980, the bank’s loans and leases grew annually at an average rate of 22 per cent. It had moved up to sixth place in size behind Citicorp, Bank of America, Chase Manhattan, Manufacturers Hanover, and Morgan Guaranty, and bragged that it was the largest bank between Manhattan and San Francisco. This heady growth was achieved at the cost of paying insufficient attention to the quality of the loans that were taken on. Part of the blame must lie with the antiquated banking laws at the state of Illinois. A prohibition against a bank having more than one branch made it hard for Continental to find customers with whom it had daily contact and whose credit-worthiness it could easily gauge. To achieve growth it was obliged to get into businesses which it did not fully understand — including energy and distant real estate. Things were made worse by Continental’s failure to establish a rigorous procedure for vetting new loans. Banks normally require new loans to be approved by a credit committee. At Continental, credit control was left in the hands of individual bank executives who

were free to pursue their pet schemes. The upshot: Continental was exposed to those industries and sectors most vulnerable to the high interest rates and depressed economy which followed. Mortgage and real estate lending accounted for one fifth of the bank’s domestic assets at the end of 1980. Continental also opened its cheque book to such unfortunates as International Harvester (S2OOM), MasseyFerguson (S4OM) and Braniff (S24M). Internationally, Continental made loans to many private-sector companies in Latin America (including SIOOM to Mexico’s Grupo Alfa) which have not benefited from debt reschedulings and IMF rescue packages. Continental’s biggest blunder was in energy lending. It lent SI7OM to Nucorp Energy, a Californian drilling outfit which went “bust” in 1982, and another S2OOM to the American subsidiaries of Canada’s Dome Petroleum. Continental also plunged into the oil business indirectly by taking “subparticipations” in energy loans made by the Penn Square Bank of Oklahoma City. When Penn Square failed in July, 1982, Continental had just over ?1 billion of these loans on its books, over half of them acquired in the previous 12 months in spite of frequent investigations of Penn Square by bank regulators. Continental has never fully recovered from the Penn Square affair. Its nonperforming loans have risen relentlessly; as a percentage of total lending, they now stand higher than those of any other large American bank. Nervous depositors have obliged the bank to pay more for its deposits. Because Continental does not have a branch network, it is more dependent on volatile money markets than on stable retail deposits. After the Penn Square

collapse, the bank turned increasingly to the Eurodollar market, where it could raise funds from other (often foreign) banks. The potential instability of this arrangement was rammed home when rumours that Continental’s holding company was about to file for court protection under chapter 11 of America’s bankruptcy law led to withdrawals of money from the bank by several big overseas depositors. The Chicago Board of Trade Clearing Corporation followed suit, withdrawing $5O of short-term deposits, although SBOM in letters of credit were left with the bank. On the week-end of May 12 and 13, Continental called on Morgan Guaranty — an old ally which increased sales of its own certificates of deposit and passed on the proceeds to Continental after the Penn Square collapse. Morgan did the decent thing again in helping to organise the $4.5 billion stand-by loan. The money was needed to repay loans made by the Federal Reserve Bank of Chicago in the week ended May 11; the loans may have been as high as $3.5 billion. The rescue demonstrated to depositors that Continental has powerful friends. One of Continental’s big mistakes since its ill-fated dash for growth has been its repeated failure to make a clean breast of its problems. The difficulties at International Harvester were well known throughout 1981,

yet it did not put its Harvester loans on a non performing basis until early 1982. The loans made through Penn Square were still being newly classified non-performing in the first quarter of this year, although Penn collapsed two years ago. Can Continental retain its independence? It may be touch and go. Confidence, once shaken, is hard to rebuild. Several large foreign banks would welcome the chance to make an acquisition in America, and takeover would be one way of restoring market confidence. Whatever the eventual outcome, Mr David Taylor, who has succeeded Mr Anderson as chairman of Continental, must raise staff morale, which has sunk to new lows as a result of the troubles. Mr Taylor might care to learn from the First Chicago’s experience. When Mr Barry Sullivan arrived there as chairman in 1980 he found that morale was poor, that the ban had little idea of direction, and that lending officers were timid, afraid that the bank could not afford to take risks. Mr Sullivan set up a small group of senior managers to focus on the bank’s strengths and give its people a sense of purpose. He brought in new management; half of the First Chicago’s top 20 executives were replaced. In an effort to get closer to the businesses of its customers (and so to make it easier to sell them a range of services),

the bank has reorganised its marketing activities along geographical lines, rather than individual industries. In September, 1983, the First Chicago moved deeper into the small and mediumsized business market by acquiring American National Bank, Chicago’s fifth biggest, from Walter Heller for $275M. Helped by the purchase of Bankers Trust’s S7OOM credit card portfolio in 1982, the First Chicago has also been extending its plastic money business. The First Chicago still has some way to go in sharpening up’ its international business, and Mr Sullivan’s critics say that he is doing too much too quickly. Even so, the hectic pace seems to be paying off. While Continental’s net earnings were falling from $226M in 1980 to SIOBM last year, the First Chicago managed an increase from S63M to SIB4M. Measured by return on assets, the First Chicago is eighth among America’s big 10 banks. Mr Sullivan’s boost to put First Chicago in the top five could soon be fulfilled. With so many newcomers in his management team, Mr Sullivan’s ambitious strategy is certainly high risk. Mr Taylor may understandably believe that risk is the last thing Continental can afford at present. But given the dire straits in which Continental now finds itself, can it afford to be risk averse? — Copyright, the “Economist,” London.