Loans to third world leave some major US banks out on a limb

Who's next after Continental Illinois Bank? Bankers and federal regulators worry about this question. Their prime concern is bad loans.

If Chicago-based Continental Illinois's troubles centered around poor management and bad loans it bought from the Oklahoma oil patch, the weakness of other money-center banks focuses around exposure to Latin American debt. Continental also has moderate foreign debt exposure.

These foreign loans were made in the 1970s, when banks brimmed with petrodollars deposited by oil-producing countries. These banks saw third-world development projects as good business. But then came the recession of the early '80s, and those expensive projects could not generate the revenue to service the loans. Some foreign governments found themselves strapped too.

The key to the health of most of the big banks in the United States is whether foreign debtors make timely loan payments. And timely payment depends on a variety of factors: future interest rates, foreign-exchange rates, the marketability and profitability of commodities these debtor countries export, the tolerance of third-world nations for austerity programs, even overall confidence in the future among lenders.

Banking analyst J. Fredrick Meinke, of the brokerage firm E. F. Hutton, notes that most banks have lent amounts of money that far exceed their reserves. And all banks depend on investor confidence.

''Almost any bank,'' he says, ''would be hurt by rumors, especially if the market is in a nervous mode. And no bank can take a run on deposits.''

Mr. Meinke admits that opinion is polarized on the issue of the financial security of banks in money centers like New York, San Francisco, and Chicago. Pessimists say debtor nations will repudiate their international debts - or at least won't service them - and therefore the big banks' problems will get worse.

Meinke, however, counts himself an optimist: ''The international debt crisis has been overdone. The crisis was two years ago, and we're over the hump. Many countries are coming back, the reschedulings (of debt payments) are going okay.''

Banking analyst George M. Salem of A. G. Becker Paribas Inc., disagrees: ''The international debt crisis is still very much with us. ... The crisis is not likely to diminish in 1984 or 1985. It could flare up again at any moment as a result of events in any of half a dozen or more LDCs (less developed countries).''

What would help money-center and regional banks alike, Mr. Salem says, would be a sustained drop in interest rates. But he says that is unlikely.

Manufacturers Hanover Trust is often cited as having the greatest foreign-debt exposure and therefore as being in the riskiest position after Continental. Becker Paribas estimates 15.8 percent of Manufacturers Hanover's loans have been made to six ''troubled developing countries:'' Mexico, Brazil, Venezuela, Argentina, the Philippines, and Chile. (Continental Illinois has 7.5 percent of its loans out to these troubled LDCs.)

In fact, only a week after rumors set off a run on Continental, rumors hit Manufacturers Hanover. This time, however, the company and the Federal Reserve acted quickly, vigorously denying the rumors.

After Manufacturers Hanover, the Becker Paribas study shows J. P. Morgan, Citicorp, Chase Manhattan, Chemical Bank, and Bankers Trust as relatively highly exposed. But each case is different. Meinke notes, for instance, that Manufacturers Hanover's foreign loans are largely out to governments and public-sector enterprises in Latin America. These, at least, have the power to raise or impose taxes to repay loans, he says; loans to the private sector are much more risky.

Some analysts, however, take the opposite point of view. They note that public-sector loans are subject to much more political pressure - nationalization, change of government, or simply a fiat by the ruling junta saying that the loan will not be paid. Even if the private sector gets socked with a drop in commodity prices or a recession, it at least plays by the rules of the game, attempting to protect its credit rating by servicing loans when possible.

E. F. Hutton has ranked the banks according to risk and profitability. While this is only for investment purposes, these ratings reflect the firm's analytical view of the strengths of money-center banks.

The strongest banks, from Hutton's point of view, are Citicorp, Bankers Trust , and J. P. Morgan: Citicorp because of innovation and a growing consumer base; Morgan and Bankers Trust because of conservatism and high reserves. Then come Manufacturers Hanover, First National Bank of Chicago, and Chemical Bank. Meinke's view is that these are good (for investment purposes) in the long term but not so good in the short term. Then comes Chase Manhattan, as an investment. Chase, he says, is slightly tricky as a short-term investment but should do okay in time.

At the bottom is Continental Illinois, where, he says, ''There is no real investment opportunity.''

''One has to see each bank and its exposure to foreign debt on a case-by-case basis,'' cautions James J. McDermott Jr., director of research for the Keefe, Bruyette & Woods brokerage. ''Problems with Argentina, for instance, could be offset by improvements with Brazil. Problems in the public sector are different from problems in the private sector''

The status of these important banks could be threatened if a debtor reneged on some or all of its loans. But despite some tough talk from Argentine financial officials, virtually all the leading debtors have been negotiating on rescheduling of loans.

''The issue of foreign debt is still a concern,'' Mr. McDermott notes, ''but foreign debt has been with us two years and the (banking) system is still here and problems are being worked out. Is the system safe? The answer is yes. There is ample evidence that banking companies are trying to reduce risks.''

Banks are at the heart of our economy. They are businesses, and like other business, they have profits, losses, marketing plans, employees, stockholders, and customers. They can be immensely successful - or they can go bankrupt.

But unlike other businesses on Main Street, most banks (and their close cousins, the thrifts - which include savings and loans, mutual savings banks, and credit unions) are linked to Washington, D.C. Commercial banks tie in with the Federal Reserve System and the Federal Deposit Insurance Corporation (FDIC); thrifts are tied to the Federal Savings and Loan Insurance Corporation and the Federal Home Loan Bank Board.

The Federal Reserve is, in effect, the bankers' bank. When a bank is short of reserves and needs money, it borrows it from the Fed. And if a bank gets in trouble, the FDIC, with its $16 billion insurance fund, steps in to bail it out by arranging a merger partner, paying off depositors, and even, in the case of Continental Illinois, taking over the bad loans.

Next: Regulatons and competitiveness in banking.

Big bank loans to six troubled developing countries *(Mexico, Brazil, Venezuela, Argentina, Philippines, Chile; as of April '84). Bank Six-country As percent of total total loans BankAmerica $7,800 9.4% Citicorp 12,500 13.0 Chase Manhattan 7,425 15.8 Manufacturers Hanover 7,825 15.8 J. P. Morgan 4,925 14.2 Continental Illinois 2,375 7.9 Chemical Bank 4,650 13.3 Bankers Trust 3,300 14.3 First Chicago 2,450 11.0 First Interstate 1,515 5.9 Source:Becker Paribas, Inc.