Investor Alert

July 5, 2004, 12:01 a.m. EDT

Inside the Vault

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By Jim McTague

NOW THAT INTEREST RATES have begun climbing, investors in bank stocks need to keep a close eye on loan quality. Rising rates often expose questionable lending practices, some of them fatal. Over the past two decades, banks sank by the hundreds during periods of rising rates. Witness the S&L debacle of the 1980s, when 563 savings and loans failed and 333 others were forced to merge. That was followed by a commercial-bank debacle that claimed 286 banks in 1990 and 1991.

In examining those blowups, the General Accounting Office laid its finger on a common culprit: loans to insiders. The Congressional watchdog agency found that poorly underwritten loans to employees, directors and large shareholders were evident at 61% of the failed banks and were a major factor in 21% of them. The problem was that loans to bank insiders were based on less stringent credit standards than loans to others, and thus turned sour more quickly.

Still more troubling, the GAO found that bank regulators had not detected the extent of the insider loan problem until after the banks had failed.

Well, guess what? Insider loans are still flourishing throughout the banking industry -- and regulators, once again, appear to have less than a firm grip on the issue. For investors in bank stocks -- or folks who simply want to stash some savings at the neighborhood bank -- the message is clear: caveat emptor.

Tables: Inner Circle

Using data supplied by the Federal Deposit Insurance Corp., Barron's has compiled a list of the 10 banks with the largest amount of insider loans in terms of dollars, plus four smaller banks whose insider loans are large compared with the banks' cushion of capital (see tables).

A bank with insider loans isn't necessarily headed for trouble, and the banks on our lists, including leaders like Wachovia /zigman2/quotes/206830028/composite WB -6.21% and Bank of New York /zigman2/quotes/200171276/composite BK -1.39% , generally look quite healthy. But as rates rise and a bank's portfolio of problem loans increases, insider loans at the institution can quickly become a concern, says Auburn University Finance Professor James Barth, who has written extensively about bank failures.

"It's an area not a lot of people are looking at anymore -- but it makes sense to look at it," says Sam Leaman, a senior financial analyst at Washington Analysis, an independent equity research firm.

Among all commercial banks, loans to insiders now amount to 4.7% of the industry's equity capital, says SNL Securities, a bank research firm in Charlottesville, Va. While that's less than half the ratio seen in the early 'Nineties, loans to insiders clearly haven't gone away.

At the 10 banks with the largest dollar volumes of insider loans, the loans represent anywhere from 4% to 14% of equity capital -- cushions meant to absorb any losses. But those ratios are allowed; sizable banks are permitted by the Federal Reserve Board to lend insiders amounts equaling up to 100% of capital.


Bank of New York's ratio of insider loans to capital is the highest of the group, at 14%. Those loans, by and large, are said not to be to individual directors but rather to the corporations that they represent.

Most banks add that many of their loans are fully secured. Atlanta-based SunTrust says 42% of its insider loans are backed by marketable securities with margin provisions. This means that the borrowers must increase their collateral if the value of those securities dips. A spokesman for First Hawaiian Bank, a unit of BNP Paribas, says that virtually all of its insider loans are commitments to lend rather than granted loans.

"Historically, regional bank-holding companies have put community business leaders and customers on their boards of directors," Milwaukee-based M&I Bank, a subsidiary of Marshall & Ilsley and No. 9 on the list, said in a written statement. "This is simply good business for us because we have qualified, successful business people on our board who know the markets in which we do business."

Insider loans are particularly common at small-town banks, because the local business people are often the best candidates to serve on the board. That's why banks with less than $100 million in assets are allowed to carry insider loans amounting to 200% of capital.

US : U.S.: Nasdaq
$ 33.53
-2.22 -6.21%
Volume: 1.34M
March 27, 2020 4:00p
P/E Ratio
Dividend Yield
Market Cap
$4.13 billion
Rev. per Employee
$ 32.54
-0.46 -1.39%
Volume: 5.76M
March 27, 2020 6:30p
P/E Ratio
Dividend Yield
Market Cap
$28.80 billion
Rev. per Employee
1 2
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