As Defaults Multiply, Observers Eye Lax Standards, Circumstance

By Weidner, David | American Banker, August 19, 1999 | Go to article overview

As Defaults Multiply, Observers Eye Lax Standards, Circumstance


Weidner, David, American Banker


It is fast becoming a leitmotif of the late 1990s: A newly created company, fresh from an emerging industry, gets walloped by an unforeseen event and then struggles to meet its debt payments under terms it can no longer handle.

Contifinancial Corp., one of a new breed of specialty finance firms, joined the chorus of companies pleading for more time Wednesday when it disclosed it was having difficulty meeting the terms of its $400 million of bank loans. Conti also announced losses of $237.7 million in its latest quarter.

Banking companies have had to cope with a rash of defaults and bankruptcies this year. Nonperforming loans jumped 12.3% in June, to 0.91% of total loans at the nation's 15 largest banking companies, compared with a year earlier, according to a study by Standard & Poor's.

The rating agency also said nonperformers are likely to be higher across the U.S. banking industry.

Despite the worsening of credit quality, analysts stopped short of declaring a credit crunch, but most agreed that in recent years banks have relaxed traditional lending standards to finance new-age companies like Conti.

As a result, many are now paying the price.

"It comes down to a 'nature or nurture' question," said David Keisman, a former credit officer for Citicorp who is now a loan analyst at Portfolio Management Data LLC. "Is it the nature of the loan when it was structured? Or is it that some event outside of the loan caused the default?"

Leo Brand, a Standard & Poor's structured finance analyst, said he believes the "soaring" default rate is the result of credit-quality problems built into the loans from their inception. Lenders and underwriters are lured to credit-challenged companies because they can make substantial fees on these loans. Investors are hungry for the high returns these deals pay. So far, neither of these inducements has shown signs of declining.

"It might be that the market takes a breather and begins to look at this risk," Mr. Brand said "It will happen sooner or later. But in terms of leverage, we're getting to the same levels we saw in the late 1980s."

But Mr. Brand cautioned that, unlike the leverage extended in the late 1980s, today's loans and bonds are being issued to companies with little or no history of profitability. So the debt looks and acts more as venture capital than as secured credit.

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As Defaults Multiply, Observers Eye Lax Standards, Circumstance
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