In the first half of the 1970s, Continental Illinois National Bank watched as Gaylord Freeman took rival First National of Chicago on a lending spree and displaced Continental as Chicago's largest bank.
Then the First stumbled. Bad loans in real estate and shipping, among others, climbed rapidly, and profits slumped. First National retrenched. A. Robert Abboud, Freeman's hand-picked successor, was fired two years ago.
While First Chicago squirmed in its new modern headquarters, conservative Continental, ensconced in its 19th century granite eminence on La Salle Street, regained its status as Chicago's biggest bank.
But in 1976, as First Chicago was paying the price for growing too fast, Continental inexplicably shed its conservative tradition and set out to become one of the nation's three biggest commercial lenders. It passed Chase Manhattan and Citicorp, and late last year Bank of America, to become the biggest lender to U.S. corporations. (Bank of America and Citibank each have nearly three times Continental's total $43 billion in assets.)
But the nation's seventh biggest bank barely had time to savor its achievement. Like First Chicago, it grew too fast, and many of its loans -- especially to real estate firms and smaller energy companies -- turned sour in the severe recession.
Long considered one of the nation's best-managed banks ("I can't say a bad thing about them," a competitor said a year and a half ago), Continental today sports the weakest loan portfolio of any major bank and has been embarrassed by its purchase of $1 billion of loans from Penn Square National Bank, which failed in July, leaving Continental with nearly $400 million in bad loans. Continental is still investigating its business relationship with Penn Square.
On Sept. 30, 4.7 percent of Continental's assets were classified as problem loans -- either past-due, renegotiated or, in the case of real estate, foreclosed. By contrast, the average money center bank -- as the dozen or so giants are called -- had problem loans equal to about 1.7 percent of its assets.
Continental Illinois will not shrink into oblivion. Its earnings will suffer until it rids itself of its excess of problem loans, but barring a complete economic collapse, Continental will remain profitable. Its broad connections with industry and its worldwide branch network assure it a continued and important role in the multinational banking system.
But it will be years before Continental lives down 1982, until competitors again will say they can find nothing bad to say about the bank.
"They management told us we could become a preeminent force in commercial lending without picking up a lot of bad loans in the process. They sold us a bill of goods," one Continental official complained.
If Continental executives sold their employes a bill of goods, they sold themselves as well. In mid-1976, with the full support of the board of directors, Chairman Roger Anderson -- a thoughtful, soft-spoken chief executive, typical of most post-Depression Continental executives -- announced a reorganization that put the bank on the growth course.
Few believed that Anderson would succeed in overtaking the giants of the corporate lending fraternity. But during the next five years he made believers of his customers, competitors and Wall Street analysts.
Continental grew faster than any other major institution, more than doubling in size between 1976 and 1981. During 1976 it averaged $4.2 billion in business loans; last year it averaged $10.7 billion, and at year-end had $12.9 billion in commercial loans outstanding.
Profits grew at an annual rate of 15 percent during those five years, while non-performing loans edged down from 3.6 percent of assets in 1977 (a hangover from the severe 1975 recession) to 1.6 percent in 1980. They crept up to 1.9 percent in 1981, a harbinger of the difficulties that would beset Continental in 1982.
Continental was dubbed the "Morgan of the Midwest," an accolade that compared the Chicago giant to Morgan Guaranty Trust Co., a big New York bank with a reputation for sound lending practices and careful attention to its mainly blue-chip customers.
Continental officials did not mind the comparison. As one Continental official said, the bank planned to be aggressive but it also planned to lend wisely.
"We prided ourselves on being good on the basics. But we blew it on the basics," said one disgruntled Continental official.
With hindsight, said one major competitor, Continental's fate was inevitable. To take a bigger share of the so-called Fortune 500 market -- already serviced by Chase, Citibank, Morgan, and Bank of America -- Continental had to undercut the competition.
If Continental shaved prices on loans to the big companies, it had to make up the lost income by taking on riskier, and therefore higher-priced, loans to smaller companies. The pressure to grow was there, but so was the pressure to keep boosting profits, said one major Continental competitor.
When the recession hit -- and it has struck the industrial Midwest harder than anywhere -- the flaws in Continental's strategy became apparent. Major oil producers encountered a decline in oil prices. Smaller firms and refineries started feeling the pinch. Developers, hit hard by high interest rates, have been unable to sell their projects. (About 25 percent of Continental's $2 billion of problem loans are real-estate related.)
Then on July 5, Penn Square failed. Continental wasn't the only bank caught in the debacle; Chase Manhattan, through its correspondent division, bought several hundred million dollars in Penn Square loans. But Continental went into Penn Square full force, and even introduced Michigan National Bank officials to Penn Square (that bank is suing Continental to recover nearly $60 million of its Penn Square losses). Competitors joked that Penn Square was Continental's Oklahoma City loan production office.
Continental officials said privately they were misled by the Continental officer on the scene, John Lytle. But Continental sources said that the bank began to have misgivings about Penn Square as early as October 1981, when some loans bought from the Oklahoma City bank did not have proper documentation.
An auditor was sent to Oklahoma City. Sources said he found no evidence of the fraud bank regulators now say was rampant in the Penn Square operation, but did discover not only that Penn Square's processing department was in shambles, but that Lytle had personal loans from Penn Square. Caution flags may have been raised, but Continental, through Lytle, continued to buy loans from Penn Square.
Gerald Bergman, head of Continental's energy lending division, had a talk with Lytle, sources said, and Lytle switched his personal loans (totalling about $565,000) to another bank. Bank sources said Continental might well have contained its exposure in Penn Square then, but Bergman became severely ill. During the critical months last winter when Penn Square was on the lending spree that regulators said resulted in its demise, Bergman was out of the bank.
By the time Bergman recovered, Continental was deep into Penn Square. The collapse of Penn Square was to cost Lytle and several others their jobs last August. Two weeks ago George R. Baker, the hard-nosed chief lending officer widely thought to be the leading candidate to succeed Anderson when the chairman retires in four years -- was forced to resign. Even Anderson's job is said to be on the line.
Wall Street was alarmed by Continental's Penn Square activities. So were investors. With a deposit base smaller than almost any other money center bank, Continental had to finance much of its growth by "purchasing" short-term funds in the money markets. Money market depositors -- who really are investors rather than depositors -- are notoriously fickle. Two years ago Continental "paper" was among the most-prized on Wall Street. Today the bank must pay a huge premium to attract funds.
The high cost of funds, relative to what its competitors pay, is one further drag on Continental's profitability. When competitors cut interest rates, Continental must follow, even though it costs Continental more to make a loan.
Continental posted a $61 million loss in the second quarter, mainly because of Penn Square. It moved back into the black in the third quarter, but earned more of its $32 million in profits from areas such as securities trading rather than from lending.
But Anderson, who declined to be interviewed, said in a letter to shareholders that the third quarter results indicate the "underlying earning power" of the bank. Profits were only $35 million lower than in the third quarter of 1981, he said, even though the bank had to deduct $58 million more from earnings this year to account for potential losses on its loans.