Acknowledging that the commercial real estate market will not soon recover, First Chicago Corp. said Monday that it will set aside $2.1 billion in problem loans at the First National Bank of Chicago, seek to sell them, and revalue them at their current worth-about 54 percent of their book value.
As a result, the company will take a $625 million pretax charge against earnings in the third quarter and earmark another $150 million of reserves for the new portfolio of ”held for sale” assets. Before Monday`s action, First Chicago`s real estate portfolio was valued at $4.3 billion. The corporation`s total assets are $47.4 billion.
To cushion the blow to earnings, the company also announced a pretax gain of $300 million for the quarter in its stellar $1.1 billion venture-capital portfolio. Nevertheless, the real estate provision will almost certainly
”wipe out” third-quarter earnings, said Adam Klauber, bank analyst for Duff & Phelps.
The pretax gain reflects a change to ”fair-value” accounting in the venture-capital business, and the real estate loss reflects ”mark-to-market” accounting, in which assets are carried on financial statements at current value rather than acquisition prices. Both changes have been recommended by the Financial Accounting Standards Board, but First Chicago is among the first banking companies to adopt them.
”We`re of the opinion that (the accounting standards) will be upon us in 1993,” said W.G. Jurgensen, chief financial officer of First Chicago.
Klauber said other banks may follow suit. ”There are others looking at it, too,” he said, predicting that First Chicago, the nation`s 12th-largest banking company, may be only the first of a wave of banks taking big one-shot losses to speed up disposal of problem property. He applauded the decision as ”a move they had to make.”
Investors seemed to applaud it, too. First Chicago`s stock closed at $33, up $2.37 on the New York Stock Exchange.
”We have looked closely at the U.S. commercial real estate market and see no recovery in the near term,” Richard L. Thomas, First Chicago chairman, said in a statement. ”Therefore, we believe it is in the best interests of the corporation and its stockholders to aggressively reduce our exposure to real estate.
”We are establishing additional reserves now because we intend to accelerate the sale of these problem real estate assets. And we are working with interested parties to transact sales as soon as possible.”
The decision was not unexpected. Under Thomas, First Chicago officials have been signaling their willingness to clean up First National`s real estate loan mess for most of 1992. For example, they had discussed the possibility of forming a so-called ”bad bank” to which the problem loans would be moved. The issuance of nearly $300 million in common stock in June-and a filing with the Securities and Exchange Commission for $300 million in preferred stock-seemed to support that idea.
Jurgensen said Monday that the ”bad bank” concept was attractive, but had so many hurdles that ”doing a bank of that size no longer seemed to make economic sense.” In addition, the new strategy gives First Chicago more flexibility in disposing of the real estate in an ”opportunistic” way, he said.
”A `bad bank` may still be one of the many vehicles” the company will use to pare its commercial real estate problems, Jurgensen said. ”We will be doing ultimately every kind of creative deal.” The time frame in which the corporation aims to dispose of the property is preferably ”sooner rather than later.”
Jurgensen said the loans and real estate in the held-for-sale portfolio constitute a heavier share of office buildings and hotels than are represented in the bank`s total real estate portfolio of $4.3 billion.
More Top Picks Best Motion Control Shoes For Flat Feet
Those property types have taken the hardest hits in the general collapse of the commercial real estate market.
Jurgensen declined to specify properties in the new portfolio, but he said they tended to be major projects done by ”top-echelon” developers.
”These are Class A office buildings and good hotels,” he said.
Jurgensen added that a large percentage of the problem assets are in California, New York and Florida. As of June 30, 49 percent of the bank`s total real estate loans are in the Chicago area, but the percentage of Chicago properties in the new portfolio is ”much smaller than that,” he said.
The bank`s second-quarter report showed that 31 percent of its non-performing commercial real estate loans are in the Chicago area.
In addition, 26 percent of the commercial real estate First National has taken over because of default is in the Chicago area, and 33 percent is in Los Angeles.
A group of properties that could well be part of the new portfolio are 19 mid- to high-rise office buildings in Beverly Hills, Calif., that the bank took over two years ago in the demise of VMS Realty Partners. The bank was owed $255.4 million on the buildings.
Real estate industry analysts expressed little surprise that the bank felt a need to take action to deal with its commercial real estate portfolio, though some expressed shock at the size of the writedown, which in real estate terms was extremely large.
”It`s a little dramatic,” said Jeffrey Davis, president of Cambridge Realty Capital, a Chicago-based real estate investment banking and consulting firm.
”The magnitude of the announcement is going to surprise a lot of people, but the fact that there are problems in those two types of real estate shouldn`t surprise people and shouldn`t cause any major rippling effects on the market,” he added.
”When you`re dealing with office buildings and hotels, if you want to sell them, you`ve got to write them down,” Davis pointed out. ”The bank decided it wanted to face all the music today.”
He said most banks and institutions with problem real estate have been reluctant to swallow such a large loss in a single maneuver.
But he said the move was made easier in terms of internal politics: The bank has new leadership, with Thomas having replaced Barry Sullivan at the helm. And it could result in gains for the bank in two or three years if the bank can get more than the average 54 percent of value it is putting on the new portfolio.
”This almost can be viewed from a positive sense, in that it enables the bank to be a lot freer in dealing with its properties,” Davis said. ”People will realize that the bank will make a deal at a price close to value.”
Somewhat less sanguine about the properties` marketability was Nicholas Buss, director of investment research for Chicago`s Real Estate Research Corp. ”We`re still seeing such a logjam in the marketplace, I`m not sure they can liquidate these even at that price,” he said.
He said the action may stimulate other banks and institutions to take a harder look at their own real estate portfolios, but couldn`t predict what they might do.
”They`ll either sit back and wait, or say, `If they`ve done it, we`re going to do it.` ”
First Chicago`s announcement, of course, does not mean the future is rosy for the banking company.
”As long as they don`t have to take additional hits, the market will be happy,” said Ken Puglisi, senior analyst for Chicago Corp. ”They are trying to get their problems behind them. Problem real estate has been a thorn in the side for a long time.
”The key is the execution. Can they sell (the property) without taking any more hits?”