Bankers Trust finds profits targeting borrowers below investment grade.

As interest rates rise and investors grow leery of the bond market, Bankers Trust Co. has gone back to the lending business in a big way.

This might seem odd for a bank that has made a major eff9rt over the past decade to build up its capital markets activities. But executives at the bank say there is nothing unusual about it.

With one foot in the lending market and the other in the capital markets, Bankers Trust is in the enviable position of being able to underwrite either loans or debt, observers say.

"We can execute in either market," says Bram Smith, managing director at BT Securities Corp. in New York.

Despite the buildup in securities underwriting over the last few years, lending remains a core business for Bankers Trust.

What's unusual is that by far the biggest portion of the lending Bankers Trust does is to below-investment-grade companies. Since 1986, the bank led or was coagent for nearly $300 billion in loans of one year or more involving over 1,000 corporations, including such big names as RJR Nabisco Inc., Time Warner Inc., and Eastman Kodak Co.

Last year alone, the bank acted as an agent or coagent on $57.9 billion worth of syndicated loans. Leveraged transactions accounted for $18.4 billion of those loans, making Bankers Trust the second-biggest arranger of syndicated loans after Chemical Banking Corp., according to figures supplied by Bankers Trust.

This year, Mr. Smith estimates, the bank will do as much or more.

"Client finance is a growing part of their business," agrees Raphael Soifer, a banking analyst with Brown Brothers Harriman. "It's coming back mainly as a result of the rebuilding of their global investment bank and the improved market for syndicated lending and leveraged acquisitions."

Loan Pricing Corp., which compiles data on bank lending, expressed a similar view. "The third quarter this year is likely to see more large leveraged deals that should bolster volume, particularly for such leveraged lending powerhouses as Bankers Trust and Chemical," the company said in a recent assessment.

Although the bank slipped slightly in the rankings for the first half of this year as other competitors targeted the same market segment, observers expect it will soon move up again.

In an example of the sort of smaller, innovative deals put together by Bankers Trust, the bank this month helped Investcorp, an international investment bank, acquire Ebel SA, a Swiss manufacturer of luxury watches.

Bankers Trust arranged a $100 million multicurrency facility to be sold off to mutual funds set up specifically to invest in senior floating-rate notes and longer-term loans.

The reason for the big emphasis on leveraged lending is that's where the interest rates and up-front fees are highest. In addition, unlike investment-grade companies, which often don't draw down a loan, noninvestment-grade companies do.

Of the approximately $400 billion in total syndicated corporate loans that banks have extended each year in the United States since 1988, roughly 75% are to investment-grade companies, Mr. Smith estimates.

However, these bring in only 10% of total earnings on lending. Noninvestment-grade lending, at 25% of the total, brings in 90% of the profits, he said.

Bankers Trust is not the only big U.S. bank that is actively marketing loans again. Other banks, hard hit by problem real estate and highly leveraged loans extended in the late 1980s, have since significantly improved both their capital ratios and liquidity, and are again looking to lending as a source of added revenues.

And with interest rates rising and investors putting more of their funds into shorter-term instruments, corporations are again turning to banks for their borrowings.

Banks and investors, too, find lending more attractive because loans use floating rates that are adjusted monthly.

"We don't take interest-rate risk, and all we have to worry about is credit risk," Mr. Smith says.

A rebound in lending is creating cutthroat competition to secure top rankings in the league tables, he added. "It's cut-and-slash pricing. A lot of shops in the city are focusing on market share," he says.

The battle to grab business away from others has not only trimmed lending margins. Some banks, the executive reports, are also waiving up-front and annual administrative fees, and are agreeing to pay borrowers' legal expenses in a bid to cut others out of the business.

So far, the increased competition among banks has affected mainly investment-grade borrowers, where Bankers Trust places less of its emphasis.

"We haven't seen the same type of pressures on noninvestment grades," Mr. Smith says.

For below-investment-grade borrowers, the fundamentals have hardly changed, even if there has been some reduction in pricing over the last two years, he notes.

Since the low point in the mid-1980s, when banks charged 2% for their up-front fees and lent at 225 to 250 basis points over the benchmark London interbank offered rate for noninvestment-grade loans, fees moved up to 4.5% in 1990-91 and interest rates to between 275 basis points and 350 basis points above Libor.

Fees are now back down to around 3%, and lending rates are between 250 basis points and 300 basis points over Libor.

The scramble to capture market share has prompted regulators as well as bankers to voice concern that banks might again be heading for trouble. In a recent interview, Chemical Banking Corp. chairman Walter Shipley said he feared banks might again be going into deals in which they were not adequately protected from risk.

Similarly, Richard Boyle, vice chairman at Chase Manhattan Corp., expressed worries recently that banks are sacrificing standards as competition for loans to large corporations sharpen.

Federal Reserve Board officials have also warned banks against relaxing their credit standards. as pressure on pricing and other credit terms increased.

Mr. Smith denies there has been any slippage in standards at Bankers Trust.

"We have had the same people doing this business for the last 10 to 12 years, and they know their credits," he says. "Our loan-loss experience is not as bad as you might think."

And when leveraged lending is done right, he adds, "the return on a risk-adjusted basis is very good."

In fact, risks on leveraged lending are well below what they were in the 1980s. Compared with an average multiple of debt to cash flow of between eight and 10, debt is now an average five to 5.5 times cash flow.

"Deals are head and shoulders above what they were several years ago," Mr. Smith says.

He adds that banks have even less to worry about because an increasing number sell off most of the loans they syndicate.

"We're a big believer in liquid assets," Mr. Smith says."We don't buy concrete."

Bankers Trust sees the business as one that mainly generates fees, says Mr. Soifer. "What they wind up getting are the fees plus the spread to the manager."

That liquidity is being enhanced further by the recent development of an active secondary market for buying and selling loans.

Many of these so-called distressed loans sell for less than 90% of their par value.

This, too, offers additional opportunities for making money in loans, since banks can stake out positions by buying loans at below-market values, then exchanging them for higher-value restructured debt or selling them off at a profit after the borrower has returned to profitability.

Still, the business is not without risks, and the biggest one Bankers Trust faces is that it might be left with a loan on its hands that it cannot sell.

"They could get stuck with a large underwriting position if some extraneous development" hurts the market, says Mr. Soifer. He recalls that that is precisely what happened several years ago when Bankers Trust did a large loan underwriting for Magnet PLC, a British company.

"They did their calculations fight, but what they didn't count on was that a funny thing happened on the way to the closing."

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