U.S. Bad-Loan Rule Change Could Hit Bank of America

Most large banks already have complied with stricter federal rules for classifying consumer bad loans, but a few notable names haven't. These include Bank of America (BAC Quote), where full adoption of the tough new standards could cause further deterioration of credit-quality indicators in its consumer finance division.

Other big financial institutions that have yet to implement the guidelines are Citigroup (C Quote) and Chase Manhattan (CMB Quote). However, these two aren't showing anywhere near the same level of past-due loans in their consumer businesses as Bank of America.

When implemented, the new rules have forced some banks, including KeyCorp (KEY Quote) and Bank One (ONE Quote), to book significantly more bad loans in their retail businesses, which include credit cards, mortgage loans and other types of installment-based consumer loans.

Slipping Away

The guidelines were issued in February 1999 by the Federal Financial Institutions Examination Council, the body that coordinates actions between the nation's five federal bank regulators. Revised in June of this year, the rules have to be implemented by the end of 2000.

Rebounding Bank of America's bounce

Source: BigCharts

In its most-recent quarterly financial Securities and Exchange Commission filing, Charlotte, N.C.-based Bank of America says that it "expects to be in full compliance with the" rules by year-end. The nation's second-largest bank says in the filing that it doesn't expect the rules to have a "material impact on its results of operations and financial condition." Citigroup says in its quarterly filing that it intends to comply by year-end and also claims that doing so won't have a "material effect" on its results. Chase didn't comment beyond saying that it aims to implement the rules by the deadline.

The goal of the FFIEC's rules was to standardize exactly when past-due consumer loans should be recognized as a loss, or "charged off." According to the FFIEC, previous policies had been "interpreted and applied inconsistently." The interagency body wants to remedy that by stipulating set periods after which nonperforming consumer loans have to be charged off. In the case of real estate loans, for example, the new rules say they have to be classified as losses after being past due for more than 180 days.

Rising Citigroup's rally

At some banks, this has meant toughening up previous classification practices, which prompted a big jump in bad loans. As a result of applying the FFIEC rules in the year's first quarter, KeyCorp booked extra consumer charge-offs totaling $57 million, which was more than half the total loan losses in the bank's consumer portfolio that quarter. And in 1999's fourth quarter, Bank One spent $200 million to bring it in line with these FFIEC standards.

Standards

Up and Down Chase's bumpy ride

Application probably isn't going to hurt overall financial results at an institution the size of Bank of America. However, another quarter of higher loan losses would deepen concerns about the bank's lending standards. A close eye should be kept on Bank of America's consumer finance division. In this business, nonperforming loans -- credits that are well past due but not yet charged off -- totaled $826 million in the second quarter, up a hefty 116% from the year-ago period's $382 million. In the second quarter, those nonperformers totaled 3.42% of total consumer finance loans, up from 0.9% in the year-earlier period.

In addition, the nonperformers are rising at a much-faster rate than the consumer finance division is growing. The division had average loans of $24 billion in the second quarter, up 36% from the year-earlier period. The new rules could force Bank of America to push its growing number of nonperformers into loss status. If the amount of charge-offs was high, then the bank would have to rebuild its bad loan reserve, and any money added to this reserve would have to be subtracted from earnings.

In the second quarter, nonperformers at Citigroup's consumer finance division, CitiFinancial, were up 33% over the year-earlier number. In the most-recent period, they were 1.32% of loans, vs. 1.26% in 1999's second quarter. At Chase, nonperforming assets in its two consumer finance businesses advanced 15% to $74 million in the second quarter from the year-earlier number. Consumer finance nonperformers in the most-recent period were equivalent to a mere 0.29% of loans.