Austin American-Statesman from Austin, Texas • 138

H2 Austin American-Statesman Sunday, October 30, 1988 Financiers promoting 'bad banks' as good idea By Kathy Kristof loa Angeles Dally Newt LOS ANGELES Big banks are creat- ing "bad banks" and they Bay that it is I good. It is the latest wrinkle in the banking in- dustry's attempt to control the losses stemming from bad loans made to Latin American nations, energy-rich states and others. First Interstate Bancorp is doing it; so is Mellon Bank of Pittsburgh. Texas fi- nancier Robert Bass has made the good I bankbad bank theme a central feature in his pending purchase of American Savings Loan Association. So what exactly is a "bad bank?" Well, think of a house that hasn't been etraight- ened up in years.

Instead of holding onto cause it frees the good bank of its loan woes. That means better earnings in the future, and higher per-share prices. But some traditionalists are concerned about the phenomenon, saying that banks can't just spin away their old problems with a puff of bookkeeping magic. "They can separate the company into two entities, but it is still the same people funding the bad assets and the good assets," said Jim Wilson, an analyst with Su-tro Co. in San Francisco.

"It may point out how the good bank is doing, but it does not solve the problems." Wilson said he expects few companies and investors to buy into the concept. "I'm not sure whether the process is going to work," added William Callender, president of California Federal Savings and Loan Association. "If there is recourse to the good bank, this is just so much smoke and mirrors." Some detractors also note that bad loans can be the result of bad management. If management does not clean up its lending policies, it is bound to eventually create a weak bank out of its good bank again and again. Then there is the cost involved, at least on a short-term basis.

Last week, Mellon reported losing $166 million in the third quarter ended Sept. 30, primarily because of $203 million in special costs associated with creating its bad bank. First Interstate also posted a third-quarter loss, of which $150 million was blamed on its soon-to-be-organized bad bank. First Interstate also had losses at its Texas-based subsidiary, which left Los Angeles' second-largest banking company with a net loss of $214 million for the quarter. The reason bad banks costs so much is an idea of how weak banks could break off their bad parts and become strong the "good bankbad bank" concept.

Investors would be able to choose whether they wanted to put their money in risky investments like the bad bank, or in relatively safe investments like the good bank. Presumably, risk-adverse investors would sell their stock in the bad bank and buy more stock in the good bank. And now that they were not risking their money on a bank with bad assets, theoretically they would be willing to pay more for shares in the good bank. That would increase the market value of the good bank and make it less vulnerable to takeover. In the two years since the idea emerged, two companies have attempted to follow the concept as Peabody envisioned: First Interstate and Mellon.

In addition, three institutions have used the plan when their troubled companies were in the process of being acquired, and the acquirer simply did not want the bad assets. One of the three was once part of Texas Commerce Bank, which was acquired by Chemical New York Corp. last year. The other was part of Allied Bancshares of Houston, which was acquired by First Interstate last January. A third will be formed when Robert M.

Bass of Fort Worth, Texas, buys American Savings in a federally assisted merger. The Texas Commerce and Allied bad banks were spun-off to shareholders, who are now slowly collecting cash for their bad assets as the companies liquidate. with large amounts of non-performing loans bankerese for loans where borrowers have not been paying for a long time. The non-performing loans weakened the banks' earnings, creating a division in the industry between Btrong banks with few bad loans and weak banks with non-performing loans that amounted to 3 percent or more of their total assets. Investors were getting so skittish about these bad loans that they were only willing to buy stock in weak banks at greatly discounted prices.

And low stock prices made these weak banks vulnerable to takeovers. Meanwhile, Drexel faced a problem. While the investment firm was large and well-known in certain financial circles, it remained an upstart in the commercial banking world. Drexel seldom won traditional bank jobs when competing against firms such as Morgan Stanley Co. and First Boston.

1 Charles W. Peabody, a vice president at Drexel and often described as "the Big Daddy of bad banks," thought about new ways to attract the bank business. Then time and circumstance began to play a role. First Interstate announced that it was going after San Francisco's BankAmerica which at that time was among the weakest of the big banks. Bank of America began to sell assets to thwart First Interstate's hostile advance.

But Peabody noticed that the assets BankAmerica sold were the good and profitable assets, not the bad assets that made it a weak and unprofitable company. That was bad, he concluded, even though BankAmerica did eventually shake First Interstate. Peabody and his cohorts came up with AP I that old TV Bet or toaster, the owners gath- er up everything they don't want and put it in their garage away from sight. Eventu-? ally, they sell or give away the whole lot. a With banks, that old toaster or TV is a bad loan.

A bank takes the loans it doesn't want on its books and spins them off into a separate subsidiary. This is the bad bank. The good loans those that probably will be paid off remain in the main "good" bank. At some point, the bad bank sells its assets and liquidates. The good bank, meanwhile, can concentrate on profitable assets and make them more profitable.

Ironically, good bankftad banks were I the brainchild of former executives of Drexel Burham Lambert the New York investment house that revolutionized takeovers through junk bonds. I Largely because of Drexel, firms that need cash have turned away from banks in favor of publicly issuing debt. I Many on Wall Street like the idea be Texas financier Robert Bass Is an advocate of the good bankbad bank theme. that the process requires the loans and other troubled assets placed in the bad bank to be "marked to market" Banks mark assets to market when they are worth less than their original "book" value. And non-performing loans are almost always worth less than originally valued.

In First Interstate's case, the bank determined its $400 million pool of loans was really only worth $250 million. The good bankbad bank origins go back to 1986 when a group of investment bankers who worked for Drexel determined there was a problem in the commercial banking industry. Banks were suffering 'Perpetual motion' drolls into patent court 1 if I By Edmund Andrews New York Time Service Patents A ft, i i WASHINGTON The stories behind some of the patents and trademarks awarded this week: Joseph W. Newman, who has i been battling the Patent and Trademark Office for nine years in I defense of what critics deride as a I perpetual motion machine, takes H1 This month, ComputerCraft is celebrating 1 1 years of service, support and superb computing values. Since we opened our first computer store 1 1 years ago, we've realized that the only way to succeed in business is to keep our customers satisfied and coming back.

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And discover what ComputerCraft has in store for you. his case to the nation top patent court on Tuesday. Newman, of Lucedale, says he has invented an electromagnetic motor that can produce 10 times as much energy as it uses. The Patent Office rejected his claim in 1979, saying the invention violated laws of thermodynamics and was impossible. That decision was upheld by the Patent Office's Board of Appeals in 1982 and by the U.S.

District Court in Washington in 1987, but Newman has not given up. "It's not a perpetual motion machine," he insisted. "What it does is convert mass into energy at 100 percent efficiency." Newman says he does this by recovering energy released from a conductor when a magnetic field collapses. Newman, who has been the subject of stories on CBS' evening news and NBC's "Today" Show, as well as in many newspapers, built a sports car two years ago that he said was powered only by his motor. Roger Hastings, a senior staff scientist at Unysis said he had performed measurements on several Newman motors, which indicated that they produced more power than they consumed.

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