Search the Internet          Tips  Sites: Finance, Investment

Enron dampens bank lending, crimps recovery

Ellen Freilich in New York

Banker John Koch was plowing through files three inches thick Wednesday, analysing Enron Corp financials and mulling a lease request from another energy firm.

Koch's bank -- Cleveland-based Charter One Bank -- already does thorough reviews of customers' ability to repay loans, even for existing clients like the energy company.

But the collapse of Enron Corp and the ensuing mistrust in corporate accounting practices caused Koch to scrutinise the financial statements supporting his customer's lease application even more closely than in the past. And Koch is studying how Enron managed to hide billions of dollars in debt to ensure his bank does not fall into a similar trap.

"We have reviewed the Enron financial reports just to see what was occurring," Koch said. "We want to understand how these activities were reflected in the financials so we can be smarter lenders."

And Koch is not alone.

"Bankers have been put on notice that they really have to read the footnotes and that maybe they shouldn't take the summary page or the income statement at face value," said David Blitzer, chief investment strategist at Standard & Poor's.

In the case of the lease application Koch reviewed, that extra scrutiny took time.

"We spent an extra two weeks to understand, first, what kind of disclosures were in the detailed footnotes of the Enron financial statements, and second, to make sure that similar kinds of things were not involved in this lease application -- and they weren't," Koch said.

BANK LENDING BUSINESS ALREADY WEAK

Bank lending was weak long before Enron made headlines due to the economy's steep inventory contraction and to businesses' choosing to take advantage of low market rates to issue notes and bonds in the debt market and pay down bank loans.

At the same time, bankers, eyeing a slowing economy, tightened standards and terms on business loans, according to the quarterly Federal Reserve surveys of bank senior loan officers, the latest of which was released early this week.

Now, against a backdrop of high business indebtedness and a decline in corporate profits, has come a new wrinkle: a crisis concerning the quality of corporate earnings, said Henry Kaufman, president of Henry Kaufman & Co.

"There's a serious questioning of the quality of earnings and that is bound to engender additional conservatism in the credit markets, whether it is a banker or an open market investor in fixed-income obligations," Kaufman said.

CRISIS OF CONFIDENCE COULD HURT ECONOMY

Some economists said the new mistrust of corporate financial statements could slow bank lending and hurt the nascent US economic recovery.

"That is exactly what happened in the early 1990s when banks pulled back on their lending as the economy came out of the 1990-91 recession and it was one of the reasons that the Federal Reserve kept interest rates at such a low level for so long," said Frederic Mishkin, Alfred Lerner Professor of Banking and Financial Institutions at Columbia University.

Even before the recent outbreak of so-called Enron-itis -- a contagious case of anxiety regarding accounting issues and quality of credit -- many economists looked for growth in 2002 totaling less than half the 7 per cent pace typical for the first year of an economic recovery, not enough to prevent an increase in the unemployment rate.

Ed McKelvey, vice president and senior economist at Goldman Sachs & Co, said the Enron fall-out was not a "deal-breaker" for economic recovery.

But other economists said it could complicate the recovery process and slow it down.

"The attitude that you can't trust financial statements is not going to make bankers feel better and the potential for stricter lending standards to have an impact on the economy is significant," said Blitzer.

The Enron collapse has caused a crisis of confidence in the entire corporate sector, not just bankers and investors, that will contribute to a lackluster recovery and a dull economic environment, said Neal Soss, chief economist at Credit Suisse First Boston.

"While CEOs are busy huddling with their compliance officers, lawyers and accountants, trying to restore public confidence in the integrity of corporate governance, they can't plan capital spending initiatives," Soss said.

This process should separate the wheat from the chaff, said one banker at a major bank.

"Companies that are strong and have integrity will have a competitive advantage from a financing perspective. They'll do fine and gain market share."

But first, questions about credit, balance sheets and the meaning of corporate profit and loss statements must be resolved by all the entities involved with business.

"Over the intermediate and longer term, this cleansing that is taking place will be very beneficial, but the implication for the economic recovery is slower growth -- rather than a big cyclical economic lift -- and a moderate, not dramatic, improvement in corporate profits," he said.

ALSO READ:
The Enron Saga