Loan losses: are they lurking where you're looking? Credit officers discuss the issues

RMA Journal, The, Feb, 2005 by Beverly J. Foster

Leveraged Lending

Leverage is moving up dramatically both in large deals and middle-market deals, Blakely observed. "The junk bond market is as frothy as ever and, in fact, it reminds me of the environment in 1998," he said. "If you look at some of the big deals of recent weeks, one fairly large deal had a leverage multiple of 7.5 times. That deal was oversubscribed, which tells me that the market has rebounded very, very quickly. The blood is hardly dry on the floor after the last round, and already we've jumped back up to where we were in 1998. The junk debt market provides a lot of liquidity to leveraged loans right now, but that market is here today and gone tomorrow. All it takes is a real shock to the system. If there is a terrorist attack, for example, you'll see the junk bond market shut down just as it did in 1998 when the Russian debt crisis hit. The junk bond market is a source of liquidity for restructuring leveraged loans--particularly for problem leveraged loans. It just amazes me how quickly we've forgotten the lessons of 2000."

Blakely recalled a comment from an earlier presentation at the conference to the effect that increased multiples being applied to these deals are just continuing to go up.

Retail

Economist Susan Hudson-Wilson had delivered a keynote address earlier in the conference that outlined regional successes and failures but stressed the concern all institutions should have about the increasingly stressed consumer. Henry said Bank of the West's $9 billion consumer portfolio, which constitutes more than a third of the bank's asset portfolio, is at all-time lows in delinquencies. "We participate only in the A market and maybe a little bit in the B market. Credit scores are going up even as our credit losses remain static," he said. "And it's unbelievable the amount of recoveries we're having. We don't know why, but the consumer is holding up well, and ours is a national portfolio with a variety of specialties." Recalling his own earlier comment, however, Henry said, "It's pretty scary not to know where we're going to go from here."

Chalk said he believes the consumer portfolio to be the one that "scares me the most, and it's not because of current performance. If you review the roots of problems of the 1980s, high leverage and fast loan growth were like mirror images. Remember the LBOs [leveraged buyouts]? We had high leverage and fast growth followed by credit problems. Then in the late 1990s the corporate market was getting more leveraged, which was the source of banks' growth. Credit problems then followed. And now we're seeing leverage with the consumer; if you look at most banks' balance sheets, you'll see that's where we're getting much of our growth. There will be a change. Ultimately after this fast growth, high leverage will have its impact on our portfolios. Not that things are going to break down tomorrow or immediately, but look out in 2005 or 2006."

On the other hand, Blakely said, "The overall performance of the consumer portfolio has been very good, and it continues to get better. It's sort of a phenomenon--I keep hearing about the consumer being so leveraged, and yet the performance keeps getting better and better. Our quarter-over-quarter, month-over-month, and year-over-year performance continues to do better in just about every category we have. So many people point to the consumer as the next battlefield; we're all focused on it, we're all worried about it, and you know what that means? That means the consumer is not where the problem's going to come from. It always comes from some place where we're not focused. The consumer portfolio is performing so well right now, we could take on more delinquency and losses for quite some time before it really gets to a bad point."