The Rescuer of Last Resort

By Stephen Koepp

Bank regulators consider taking over Continental Illinois

"Dreams, as we all know, vanish when we wake. Nightmares vanish too," wrote Continental Illinois Bank Chairman David G. Taylor in a memo to his beleaguered employees earlier this month. But Taylor's corollary proved only half true. The nightmarish flight of Continental's customers that led to the bank's near collapse two months ago has continued. Since May, customers are rumored to have withdrawn two-thirds of Continental's $30 billion in deposits. Last week bank officials appeared to have virtually given up looking for another bank or for some wealthy buyer to infuse new money into the institution. Instead, they were meeting in Washington with is federal regulators to discuss a drastic, last-resort solution in which the Government would assume ownership of Continental. If the deal is concluded, it will be the first nationalization of a major bank in U.S. history.

As part of one plan being discussed last week, the Federal Deposit Insurance Corporation would accept most of Continental's bad loans, estimated at $4 billion, in return for an estimated 80% stake in the bank. FDIC Chairman William Isaac would then dismiss Taylor and other top officials and install new bank management. In addition, observers say, the FDIC would substantially reduce the bank's $34 billion in assets by selling some holdings. The regulators may spin off the Chicago institution's weakest units into another bank, already dubbed "Trashco" by Continental employees, which could then be declared bankrupt. Federal officials believe that the down-sized bank, relieved of troubled loans to debtors ranging from oil drillers to Brazil, could regain public confidence and earn a profit. Then, at some future time, the FDIC might be able to sell Continental and recoup some of its investment.

The big losers under this plan probably would be Continental's stockholders. The FDIC continues to honor its earlier promise that all the bank's depositors will be protected against losses, even those with accounts larger than the legal $100,000 coverage limit. Stockholders, though, could lose the largest share of some $2.2 billion in equity if the Government takes over. Stockholders have already taken a beating in the market. Since last September, Continental stock V, has fallen from 25 1/4 to 3 1/2. Said one Chicago investment analyst last week: "This is as if you were in the Viet Nam War and didn't get out on the helicopters. That's what's happening to the stockholders."

When the run on the bank started in May, sparked by rumors that Continental was unsound and was about to be sold to three Japanese financial institutions, the FDIC, the Federal Reserve and dozens of banks began supplying billions in funds in an effort to stop the panic. A package of more than $10 billion in loans was offered, but it was only the FDlC's pledge to protect all deposits, no matter how big, that halted the outflow of funds.

Once the run had been stopped, the FDIC tried to find a private buyer for Continental, but it had no takers. Such interested parties as Citicorp, First Chicago and the wealthy Bass family of Fort Worth all considered the deal and decided that Continental had more problems than they could handle. Since no one else was willing to step forward, the FDIC seemed to face no alternative but to take over the bank. Last week Continental and the FDIC still hoped that some private group might step forward, but they were fast losing all optimism about that possibility.

During the past two months, Continental has been sharply pruning its operations. More than 300 employees, mostly clerical workers, have accepted early retirement. The bank has raised some $6 billion by calling in loans and selling its London-based merchant-banking subsidiary.

But Continental has continued sliding downhill. Said Taylor last week: "Over the past few weeks, we have observed a loss of some of our business and, regrettably, some of our colleagues'. Uncertainty has been our enemy and will continue to be until the details of engineering the new Continental are finished and announced. " Continental officials last week appeared to be delaying announcement of the bank's second-quarter results, which are expected to show large losses, until a rescue plan is ready. It was believed that disclosure of the figures could spark another panic.

Some bankers doubt that a slimmed-down Continental under the control of the FDIC would be a workable venture. They argue that the bank could become too bogged down in bureaucracy to compete profitably with other banks. Staff morale at Continental would probably suffer, and top executives would leave the bank. At one time the largest commercial and industrial lender in the U.S., Continental would rank as only a regional player, half the size of its former head-to-head rival, First Chicago (assets: $40.5 billion).

Reports of the possible takeover of Continental prompted nervous speculation among both bankers and investors. One of the biggest concerns is about how the FDIC will handle Continental's $2 billion in Latin American loans. Bankers fear that the FDIC will write them off and take the loss. Many other large U.S. banks still carry most Latin loans on their books at full value, and a write-off of Continental's loans would put pressure on such banks to do the same.

The long agony at Continental and the worsening of the Latin American debt crisis have become a drag on the whole banking industry. During the past three months, stock prices of major New York City banks have fallen more than 13%. Said James Wooden, the bank-industry analyst for Merrill Lynch: "Continental's problems are probably unique and not transferable to other banks. On the other hand, they represent a very serious do mestic banking problem that must be dealt with. The sooner those problems are solved, the better."

-- By Stephen Koepp.

Reported by J. Madeleine Nash/Chicago and Christopher Redman/Washington

With reporting by J. Madeleine Nash/Chicago, Christopher Redman/Washington