Now, The Third World May Do Banks A World Of Good

For years, bankers have spelled misery L-D-C. During much of the 1980s, it seemed as if less-developed countries would never be able to repay the mountain of debt that banks had lent them over the years. The global banking system came under growing strain as Latin American governments defaulted on interest and principal payments. In the U.S. alone, banks took a staggering $25 billion hit in 1987 to build reserves against Third World debt.

Now, however, the LDC crisis may be coming to a welcome end. The biggest debtors have been negotiating settlements with banks. Moreover, some pending deals could prove an unexpected financial bonanza to several big banks with the largest LDC exposure.

Bankers reached an agreement with Argentina in April and are nearing a pact with the last big holdout, Brazil. Under the terms, the banks will swap most of their nonperforming loans for interest-bearing bonds backed by U.S. Treasury securities purchased by Argentina and Brazil. That should eventually translate into earnings gains for some banks, because the value of the bonds will be greater than the value of the nonperforming loans, which banks have heavily written down. The debt accord will also help clean up bank balance sheets and free up much of the remaining $4 billion that U.S. banks have in reserves against Third World debt.

Of the dozen or so U.S. banks with significant LDC debt on their books, "all stand to gain to some degree," says analyst Diane B. Glossman of Salomon Inc. But the biggest winners are expected to be such major institutions as Citicorp, Chemical Banking, Chase Manhattan, and BankAmerica (table).

So far, bankers are playing down any talk of a windfall--and for good reason. When Argentina and Brazil repay their debt, banks will merely be collecting money already owed them. Even then, banks will never recover the entire amount. What's more, analysts say, bankers are hesitant to draw attention to their potential profits for fear that Brazil could harden its stance in current debt talks. All the same, "obviously, it will be positive for us," says Citicorp Vice-Chairman William R. Rhodes, a lead negotiator for the banks.

BRADY'S BUNCH. Banks negotiated similar loan-for-bonds swaps with Mexico and Venezuela in 1990. The bonds came to be known as Brady bonds, after Treasury Secretary Nicholas F. Brady, who crafted the idea. Yet the current deals are far more lucrative for the banks, because they have written off so much of their LDC debt since then. Under the pact with Argentina, which will likely be copied for Brazil, banks have two options: They can forgive 35% of their loans in exchange for floating-rate bonds, or they can receive the face amount of their loans in below-market, fixed-rate bonds. Both have 30-year maturities.

Interest arrears, which aren't carried on bank balance sheets, would be paid off in a similar fashion. Argentina, which owed $8 billion in back interest at the end of 1991, will pay out $700 million in cash and short-term securities and the rest in 12-year, floating-rate bonds that are not collateralized.

The impact of these swaps on banks' financial statements could be dramatic. Argentine loans are valued on the books at most banks at 30 on the dollar; Brazilian loans vary from 35 to 37 . In both cases, banks could receive securities with a face value of 65 on the dollar after debt forgiveness.

In theory, banks could book the difference as income if they eventually sold their bonds. Argentine debt was recently trading at 48 on the dollar and could trade higher when the banks finally exchange loans for bonds, possibly by the end of the year. Bankers, however, will probably wait to see how the new debt deals work out before deciding what to do with their bonds. Even then, individual banks may account for the asset swap differently.

Even if banks keep the bonds, revaluing them upward over their full 30-year lifetime, there are bound to be bottom-line benefits. Moreover, analyst David S. Berry of Keefe, Bruyette & Woods Inc. estimates that banks will earn twice as much interest from Brady bonds as they otherwise would have from Argentina and Brazil. All this means more income. Chemical and Citi, Berry says, might earn an extra 40 to 45 a share next year. Keefe Bruyette currently expects Chemical to earn $5.50 a share in 1993; the forecast for Citi is $2.75.

LATIN LOVERS. The benefits also extend to bank reserves. Some banks have already drawn on their Third World debt reserves to shore up provisions against other bad credits, such as commercial real estate loans. But the pace could pick up at some banks if Argentina and Brazil keep up timely interest payments on their bonds. If so, this could reduce the amount of future loan-loss provisions, which have been a drain on bank earnings in recent years.

The biggest beneficiary may be Chemical, which has $1.3 billion in reserves against LDC loans. If Chemical switched that amount into its general reserve against bad loans, Berry estimates, its reserve coverage, a key measure of its ability to cope with bad loans, would rise to 85% from 66%.

Finally, bankers are eager for more business in Latin America once the debt pacts are wrapped up. Although there is little interest in government lending, bankers are scrambling to do investment banking and trade finance in the strengthening economies of Latin America. "These countries that were very bad credits in the '80s are some of the biggest export clients for the U.S.," says Citi's Rhodes. Indeed, with the debt question laid to rest, bankers are betting that in the 1990s the Third World may generate fat profits, not bad loans. The letters L-D-C, it's becoming clear, now spell relief.

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