While second-quarter revenue growth has been healthy enough at most banks to offset problem loans, analysts say they are still concerned about rising nonperformers.
Weakening credit portfolios have turned up at banks across the country, including Amsouth Bancorp, Fleet Financial Group, Wachovia Corp., and Firstar Corp.
"Despite the robust economy ... nonperforming assets are heading up at some institutions," said Kathy Shanley, an analyst with Gimme Credit Publications Inc. in Wilmette, Ill. It is "a trend that could accelerate as the economy slows."
"We think banks should be building up their capital now against the inevitable downturn, not buying back shares to appease shareholders, however disgruntled," she said.
That bad loans may soon become a front-burner issue for banks cannot come as much of a surprise. For two years regulators, industry analysts, and loan professionals have warned that credit standards have eroded to uncomfortable levels.
Since nonperforming loans have been at historic lows recently, it only makes sense that they are going to come up, said Allen Sanborn, the president and chief executive officer of Robert Morris Associates, a credit risk trade group.
At Boston-based Fleet, nonperforming loans reached $318 million in the second quarter, a 13.6% increase from the first quarter. Milwaukee-based Firstar also had a double-digit increase.
But the real blot showed up at Wachovia, a company renowned for its strict credit culture. The 65% increase at the Winston-Salem, N.C., company was attributed mostly to one bad loan to Loewen Group Inc., a Canadian funeral services company now in bankruptcy proceedings.
But the second quarter did not provide the first indication that loan quality had started to weaken. At the end of 1998 a Bank of America Corp. study found that more loans were being amended, mostly because borrowers were having trouble meeting terms of loan agreements.
In March, Standard & Poor's Corp. said the volume of defaults in 1998 was higher than in any year since 1991-the apex of a crushing credit cycle that sent many banks and thrifts into insolvency.
Last year 48 companies defaulted on $10.9 billion of debt, the third- highest annual default level on record since 1981, when S&P began studying rated bank loans.
The rating agency also found that leveraged loans-credits made to companies carrying below-investment-grade ratings-had alarmingly high default rates. For instance, a near-investment-grade company, rated BB, had an 8.89% chance of defaulting within five years. A B-rated company's default chance is 20% during the same period.
Since lower-grade borrowers usually pay higher fees for loans, they are exactly the kind of borrowers banks have been pursuing. In 1998, 51% of new loans were to companies rated BB or below, compared with 16% in 1991.
"Banks are going further out on the risk curve to generate loans," said Stephen Biggar, an analyst with S&P's equity group. "Reserves are as good as they've been any time in history. If there's a continuation of banks running out on the risk curve, there could be credit quality difficulties down the line."
If recent news is any indication, the second half of 1999 could be worse. For instance, Iridium LLC is in a desperate bind to fend off creditors that lent it $800 million as part of a syndicated loan led by Chase Manhattan Corp.
Since March, Iridium, a satellite telecommunications company, has tried to bolster its customer base. Meanwhile, Donaldson Lufkin & Jenrette Inc. is attempting to restructure the company's $2 billion in debt.
Lawrence A. Cohn, an analyst with Ryan, Beck & Co., said only time would tell whether nonperforming loans will become a more thorny issue for banks in the second half.
Nonperforming loans "raised some concerns in the first quarter," Mr. Cohn said. "We've got a smattering of companies where there have been some issues. It's still very early at this stage to see what kind of impact there will be."
Ultimately, says Robert Morris' Mr. Sanborn, default rates are extremely low even though nonperforming loans may be on the rise. For instance, at PNC Bank Corp. the ratio of nonperforming assets to total loans was 0.59% at the end of the second quarter, compared with 0.58% the preceding quarter and 0.55% a year earlier.
Still, he said, "I think it's very prudent that banks may be saying, 'We've had a nice run, but we better take some reserves.'"
