New England's Shaky Banks: Out In The Cold?

When regulators selected a buyer for Bank of New England's failed units, bankers from Maine to Connecticut were exultant. A solution to the region's worst banking fiasco, they believed, would ease the crisis across New England. But most important, they reasoned, the selection of Fleet/Norstar Financial Group Inc. and Kohlberg Kravis Roberts & Co. would encourage other investors to pour much-needed capital into the area's troubled banks. In picking a bidder financed by a nonbank investment firm, regulators likely shared that expectation.

Unfortunately, the New England bankers and the regulators will probably be disappointed. Private investors are studying the Fleet-KKR deal with great interest. But they are unlikely to commit much in the way of funds for acquisitions without government assistance. They will even shy away from government-sponsored "open bank" deals, in which the Federal Deposit Insurance Corp. injects capital into operating banks. All they want are Bank of New England-type deals, where the FDIC assumes all the risks and the buyer is almost assured of lucrative returns.

This does not augur well for the government. The FDIC could be required to cough up billions more than the $2.5 billion the BNE bailout is likely to cost before the New England banking crisis is under control.

One clear sign that outside investors are only interested in failed bankopportunities is the experience of Bank of Boston Corp., one of the bidders for BNE. It lined up $600 million worth of commitments, provided it won the BNE contest. But when its bid failed, the commitments evaporated. "Nonindustry investors are going to gravitate to failed bank situations, because it gives them an opportunity to start with a clean slate," says Robert A. Nau, managing director of Salomon Brothers Inc. "That's where the action is," adds investment banker Edward Annunziato of Merrill Lynch & Co.

There's no doubt that the BNE deal is sweet. In return for $625 million, Fleet and KKR picked up $12 billion in interest-bearing assets. Fleet also has an option to return to the FDIC any loan it doesn't want over the next three years. The FDIC indemnified Fleet from lawsuits involving BNE and voided BNE's leases, allowing Fleet to close branches.

STOCK SURGE. Although big returns are not expected for four years, KKR and its investors already have earned about $140 million in paper profits. As part of the deal, they agreed to purchase $283 million in Fleet preferred stock, at $17.65 a share. They also received warrants to buy 6.5 million shares of Fleet. The stock now trades at 24, up 36% since the deal was announced on Apr. 22.

Many private investors are clearly intrigued by bank deals. LBO firms are examining likely acquisitions. In addition to the potential riches produced by the BNE deal, they have been attracted by the recent surge in bank stocks. "It's pretty clear that a lot of people are interested in investing in recapitalized banks of the future," says Harrison Young, the FDIC's chief negotiator in the BNE transaction. "It's true at all size levels, including community banks."

Still, it's becoming clear to bankers that potential investors will only play if they get the sort of deal that KKR got, especially the limitation of downside risk. Banks throughout the region are still carrying a pile of bad loans on their books (table). Investors want no part of bad assets. Only "a purged balance sheet can bring in new capital," says Brian Smith, a former counsel to the Comptroller of the Currency.

And that's not the only liability investors don't want. In New Hampshire, dozens of real estate developers have filed suit against local banks for calling in loans or restricting credit lines. Other banks are committed to long-term leases on unwanted offices and branches that make cost-cutting hard. "No one in their right mind is going to make an investment up here without indemnification," says one New Hampshire bank executive.

The stiffer terms that investors are demanding is disturbing news for New England's more capital-starved banks. For months prior to the BNE sale, many had been working on their own deals to raise money. Encouraged by FDIC Chairman L. William Seidman, the banks hoped to attract investors with detailed plans for cost reductions and asset sales. And they were counting on fresh FDIC capital to create a more appealing environment for investors. Regulators prefer providing open-bank assistance to banks that can stand on their own. That way a bank can continue to function and preserve its franchise.

Things aren't working out quite that nicely, however. Consider Dartmouth Bancorp in Manchester, N. H. With $977 million in assets, the bank is burdened by bad real estate loans totaling 15% of its portfolio. It was trying to put together a deal with private investors that included a merger with crosstown rival Numerica Financial Corp. Included in the deal would be some open-bank assistance from the FDIC, say bankers and investors. Now, however, investors want the FDIC to shield them against bad loans.

GROWING PRESSURE. Another deal in jeopardy involves Citytrust Bancorp Inc. in Bridgeport, Conn. With $2 billion in assets, the bank had hoped to use FDIC assistance to attract private capital. Analysts now expect it may have to fail before any investors make a commitment.

Duplicating the Fleet-KKR deal is bound to be costly for the FDIC's Bank Insurance Fund. The fund is already under growing financial pressure. The General Accounting Office, which is currently auditing the FDIC's 1990 financial statements, says the reserves in the fund totaled no more than $5 billion at yearend. That's a record low of 26~ per $100 of deposits. The FDIC still insists that the fund has $8.4 billion.

In getting New England banking back on an even keel, regulators may have no other choice but to keep shelling out cash. The only enticing alternative for investors might be a merger that generates huge cost savings. Even then, the pile of bad loans at most New England banks could dissuade investors. Both Bank of Boston and BankAmerica Corp. of San Francisco are rumored to be interested in acquiring Shawmut National Corp. in Hartford. But analysts say that such a deal would probably need major FDIC assistance. "You can't sell it with a bad loan portfolio," says an investment banker. "No one would show up."

The marketplace may help solve the New England banking crisis. But it increasingly looks like the government will have to do most of the work.

          Nonperforming loans as a percent of
                total bank loans*
      CONNECTICUT         10.4%
      MASSACHUSETTS        8.0
      RHODE ISLAND         7.1
      MAINE                4.3
      VERMONT              3.0
      NEW ENGLAND          7.8
      NATIONAL             3.7
      *As of Dec. 31, 1990
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