Banks in State Best at Shedding Foreign Loans : Security Pacific Parlays Its Expertise Into Profits by Helping Other Institutions

It was not your typical international banking transaction.

Twelve businessmen and government officials were standing outside the home of a high-ranking Honduran bureaucrat in the capital of Tegucigalpa last spring. He had left his sick bed to come outside and sign the documents closing a novel $10-million deal.

Suddenly the group’s focus shifted from the papers to a man coming down the street. He was staggering and appeared to be drunk. He also was waving a revolver in the air.

The gun was of concern to the assembly, largely because tensions had been running high since Nicaraguan troops had crossed the border into Honduras a few days earlier.

“Don’t worry,” a Costa Rican businessman assured the American banker at his side. “My Beretta is in my boot.”

The banker, Antonio M. Angotti, turned out to be one of the few unarmed people in the cluster. Almost everyone else, he noticed, had a hand on a holster as the drunk stumbled past harmlessly.

Angotti described his Honduran adventure in a recent interview as an example of the aggressiveness used by his employer, Security Pacific, to reduce its loans to less developed countries, or LDCs, by about $1 billion this year.

Throughout 1988, the nation’s big banks have chopped their loans to troubled LDCs by selling them at a discount on the growing secondary market, by writing them off as losses or by swapping them for ownership interests in local businesses.

Biggest Reductions

Statistics compiled by Salomon Bros., a New York investment house, show that the 13 big U.S. banks with the heaviest LDC exposure had reduced their loans to developing countries by $6 billion through the end of the third quarter. That brought their total LDC exposure to $43.8 billion, down from a peak of $51.6 billion at midyear 1987.

The most significant reductions have come from three big California banks, Security Pacific and First Interstate in Los Angeles, and Wells Fargo in San Francisco. Indeed, Security Pacific and Wells Fargo have achieved the most impressive reductions of any big banks and First Interstate is close behind.

“The California banks have been more aggressive and up-front about charging off these loans and selling off these loans in the secondary marketplace,” said Thomas H. Hanley, managing director at Salomon. “The bottom line of it is that, in the stock market, investors prefer the West Coast banking institutions. During most of the past month or so, the stocks of both Security Pacific and Wells Fargo have been hitting new price highs.”

Wells Fargo cut its Third World debt portfolio by $1.2 billion in the first nine months of the year, reducing the total to $518 million. At Security Pacific, loans to developing countries were down about $1 billion through the third quarter, leaving about $900 million on the books.

The progress was not quite as strong at First Interstate, where developing countries’ debt was cut $400 million in the first nine months of the year, leaving $731 million on the books.

A key means of evaluating banks’ success in reducing their LDC loan exposure is determining what percentage of an institution’s equity is represented by the outstanding loan portfolio. The calculation is made after the loan-loss reserves for the debt are subtracted from the loan balance. The lower the percentage of equity represented by the troubled loans, the better for the bank.

According to Hanley’s calculations, the net balance of Third World debts at Wells Fargo is only 17% of equity. At Security Pacific the figure is 20%, and at First Interstate it is 29%.

By contrast, the figures for the big New York banks at the end of the third quarter show that developing-country debt represents a potentially greater threat to the institutions’ financial health. The figures range from a high of 230% at Manufacturers Hanover to 98% at Citicorp.

San Francisco-based BankAmerica, which has more Third World debt and weaker earnings than the other big California banks, is more in line with the New York banks than with its California rivals. Its net LDC debt was 175% of equity, according to Hanley, and its total exposure was more than $7 billion.

The success of Wells and Security Pacific in cutting their loan exposure in developing countries has boosted their stock prices. But Security Pacific has found another benefit in the process.

Alone among California banks, Security Pacific has transformed the expertise gained in disposing of its own debt into a profit-making business brokering deals for other institutions.

Special Trading Desk

“Our initial problem two years ago was to try to handle our debt,” said Richard E. Keller, a senior vice president in Security Pacific’s merchant banking division in Los Angeles. “Out of that work and effort and learning the markets, we ended up finding that we could be of assistance to other institutions.”

A central part of the assistance is a four-person trading desk in the New York offices of Security Pacific’s international merchant bank. There, Tony Angotti, a 30-year-old vice president, oversees trading in the debt owed by the governments of 10 Latin American nations, the Philippines, Morocco, Nigeria and Poland.

Most transactions involve loan sales on the secondary market operated through a few brokerages houses and banks. The loans are sold at a discount that varies from week to week and country to country. Mexican debt has been dropping steadily to 45 cents on the dollar; Argentine debt has dropped to 20 cents to 21 cents per dollar.

A smaller number of deals are the debt-for-equity swaps in which a bank exchanges its debt for an ownership interest in a business in the foreign country. This tactic allows the bank to avoid a big loss by selling at a deep discount, but the new equity leaves the bank exposed to the vagaries of these troubled economies.

Perhaps the most challenging and potentially profitable transactions are “off-the-market” deals in which dollar-denominated loans are converted into local currencies for use in the foreign country.

Both Parties Benefit

For example, a foreign government owes a U.S. bank a debt that is denominated in dollars. The bank arranges to sell the debt to a private company at a dollar price above the discount on the secondary market. The company negotiates with the foreign government to exchange the loan for local currency at its face value.

Thus, the government conserves dollars, gets the loan off of its books and encourages investment in the local economy. The bank gets more for the loan than it would have on the secondary market. The company exchanges dollars for local currency at far above the prevailing exchange rate and uses the money to finance its local operations.

One of the first transactions of this type occurred in 1985, when the Mormon Church bought several million dollars worth of Chilean debt from a European bank and converted it to pesos to finance its missionary program in Chile.

Late last year, Security Pacific decided to get rid of its $10-million loan to the government of Honduras. The market for Honduran debt was about 10 cents on the dollar, and there were no cash buyers even at that price.

Angotti decided to find a business in Honduras to buy the debt at a discount and convert it to local currency, lempira. He began by telephoning businesses in Miami that import goods from Honduras, collecting names of big exporters from Honduras and contacting them with his deal.

The transaction was complicated because, unlike some countries, Honduras had never permitted such a conversion. These conversions require government approval because it is the government’s debt.

Eventually, Angotti found a group of Costa Ricans planning to expand a big ranch in Honduras. He convinced them that they could pay 25 cents on the dollar for the $10-million debt and convert it to lempira.

After several more weeks, the Honduran government agreed to the concept, and Angotti had to go to Tegucigalpa to get the final signatures on the documents. Various factions in the government were still uncertain about the deal, and the only official willing to approve it was sick at home when Angotti arrived.

Multinational Buyers

Angotti, the Costa Ricans and several government officials piled into cars and drove to the man’s house, where he came out into the street and signed the papers--after the episode with the pistol-waving drunk.

“The critical element is to find buyers,” Angotti said.

The usual buyers are multinational companies with operations in Latin America or local businesses that can convert the debt to local currency. But some foreign governments are also buying their own debt, operating quietly through intermediaries since most loan agreements do not allow them to purchase their debt at a discount. For the governments, the lure is great since they can pay 50 cents or less on the dollar to retire burdensome foreign debt.

Brokers involved in the secondary market say that Mexico has bought back a sizable amount of its debt through intermediaries in recent months.

Other buyers are sometimes wealthy people in the country. They purchase the debt at a steep discount and convert it to local currency. Angotti and others said Argentinians are especially adept at this practice.

The market for the debt of some small countries is very thin. So when a major institution wants to sell a large amount of debt it must tread carefully or the price on the secondary market can plummet.

In late 1987, a U.S. bank destroyed the market for Costa Rican debt by selling a $55-million chunk. The discount was about 39 cents when the bank started to sell quietly. The last $100,000 piece was sold at 10 cents on the dollar, and today the market stands at 9 cents.

A version of that tactic is affecting the entire market for LDC debt. In 1987, U.S. banks with big LDC exposure set aside painfully large amounts of money to cover potential losses. Now, many of those banks are trying to leave the arena, and the price of debt for almost every nation has dropped steadily.

“Prices are sliding, and there isn’t sufficient demand to shore them up,” Security Pacific’s Keller said.

But deals are still being struck. Just last Wednesday, Angotti brokered the sale of $38 million worth of Mexican debt for another U.S. bank.