Administration Issues Warning About Perils of Big Banks’ LBO Lending

The Reagan Administration expressed concern Monday about the rising level of bank lending for leveraged buyout transactions, particularly at the nation’s largest banks.

Two big California banks, Security Pacific and Wells Fargo, are among the nation’s biggest lenders for LBOs, which involve using a high level of debt to acquire a company.

A document released as part of the fiscal 1990 federal budget, which was sent to Congress on Monday by President Reagan, said the Federal Deposit Insurance Corp. has become increasingly concerned as banks have stepped up their concentration of lending for LBOs.

The FDIC regulates the nation’s banks and insures bank deposits.

“The concern is that if interest rates rise or if an economic downturn occurs, many highly leveraged businesses may default on their loans, thereby saddling banks that financed them with losses,” the document said.

L. William Seidman, chairman of the FDIC, said banks have already invested $150 billion in LBOs and nearly 10% of the new loans at the nation’s biggest banks are for buyouts, according to the document.

LBO lending was a major source of earnings for many large banks in 1988, with fees and interest rates pegged at above-market rates. But Monday’s warning was not the first.

Alan Greenspan, chairman of the Federal Reserve Board, also has expressed concern recently over bank LBO lending, and industry analysts have warned that the loans pose a large potential risk to some big banks.

San Francisco-based Wells Fargo had the one of highest concentrations of LBO loans among the nation’s major banks at the end of the third quarter on Sept. 30, according to figures compiled by George M. Salem, an analyst at Prudential-Bache Securities, a New York investment firm.

Salem said Wells Fargo’s portfolio of $3 billion in LBO loans represented 8.1% of its total loans, second behind Bankers Trust of New York, where $2.8 billion in LBO loans made up 11.1% of total loans.

By another of Salem’s measures, Wells Fargo had the heaviest concentration.

The $3 billion in LBO loans equaled 140.9% of the bank’s common equity, or the net worth of the institution.

Security Pacific, the Los Angeles-based banking company, had $2.6 billion in exposure to LBO transactions at the end of the quarter, 4.8% of its total loans and equivalent to 76.1% of its net worth, according to Salem.

At Citicorp, the nation’s largest bank, LBO loans were $4.5 billion, 3.1% of total loans and 58.9% of net worth, according to Salem.

In his analysis, however, Salem acknowledged that the numbers are approximations, because no precise definition of an LBO loan exists.

Some of the banks have objected to Salem’s figures. For instance, the Wells Fargo figure includes standby letters of credit, a level of exposure below that of a loan.

A spokeswoman for Wells Fargo said she could not comment on the issue because of restrictions associated with the preparation of its fourth-quarter earnings report.

But on Oct. 25, the bank’s chairman and chief executive, Carl E. Reichardt, played down concern over the potential LBO problems in a question-and-answer session after a speech.

He said the loans were diversified geographically and by industry to minimize any potential economic problems.

Security Pacific said the person who could comment on the LBO issue was in a meeting Monday and could not be reached.

California’s other two big banks, Bank of America in San Francisco and First Interstate in Los Angeles, pared down their LBO lending in 1988. B of A’s exposure on Sept. 30 was $1.1 billion, according to Salem, and First Interstate said its LBO loans totaled $412 million.

The document also said regulators were worried about investments in high-yield, high-risk debt known as “junk bonds,” an activity popular with some of the nation’s fastest-growing savings and loan firms.

Companies financed by junk bonds would also suffer in an economic downturn or if interest rates jumped, creating a potential risk for the S&Ls.;