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(FORTUNE Magazine) – The stunning collapse of the Penn Square National Bank three years ago has had many unexpected consequences, among them two good books. One was Mark Singer's Funny Money (Knopf, $15.95), a humorous and gracefully written account of the fiasco, which raced onto the best-seller lists last summer. The new entry, Philip L. Zweig's Belly Up (Crown, $17.95), also deserves to get there. It is a fat book, 500 pages long, crammed with detail that is often hilarious, shaped with a high order of narrative skill, and probably a better guide than Funny Money for readers seriously wishing to figure out what made possible those incredible happenings in Oklahoma City.
The bank failure seems unbelievable on several different counts. Like all national banks, Penn Square was regulated by the Comptroller of the Currency, and the Comptroller's office had plenty of reason to focus on this particular bank. As early as 1977, examiners from the Comptroller's Dallas regional office had shown concern about the bank's loan portfolio. In 1980 they turned up a number of improper lending practices at Penn Square, called in the bank's directors for a dressing down, and forced them to sign a document promising to mend their ways -- for example, to stop granting loans on inadequate credit information. But somehow or other the Comptroller's office never adequately monitored the bank's subsequent behavior; furthermore, it never got around to another full-scale review of Penn Square until the spring of 1982, by which time the bank was beyond saving.
So question No. 1 is why the enormous federal regulatory apparatus came off looking overmatched when confronted with a problem bank in an Oklahoma City shopping mall.
The question is especially puzzling because the bankers in question had to look like problems to anyone who gave them even half a glance. Penn Square's downfall was not attributable to some conservative-seeming graybeard with a secret passion for the race track. The man who principally did in the bank was Bill G. Patterson, a flamboyant young (early 30s) man whose friends called him Monkey Brain.
Patterson, the man in charge of all energy loans at Penn Square, enjoyed tossing food around in restaurants.
He thought it clever to drink beer or Amaretto and soda out of his shoe. He paraded around in bizarre costumes: once, during a visit to a Las Vegas hotel, he materialized in public wearing a yellow cap and angel wings, and nothing else. On another occasion he showed up at the bank wearing a Nazi general's uniform, a gift from an admirer. (The outfit seems not to have reflected Patterson's politics, only his zaniness.) He also found it amusing to make loan commitments on cocktail napkins.
So question No. 2 is why anybody in his right mind would trust a banker like Patterson.Here again, the question is even tougher than it might sound at first. The people victimized by Penn Square doubtless included some elderly widows and inexperienced small businessmen. But the principal victims were other banks, all of them substantially larger than Penn Square. They were done in by their purchases of bum loans from Penn Square. The loans contributed mightily to the near collapse of Continental Illinois and to the forced merger of the other main victim, Seafirst of Seattle (now part of Bank of America). Singer estimates in Funny Money that in the aggregate the banks purchasing loans from Penn Square ultimately wrote off more than $1 billion of them.
Question No. 3 is about the mindless management that allowed those other bankers to buy all that worthless paper.
PENN SQUARE was launched modestly in 1960 by one Ben Wileman, the developer of the shopping mall in which the bank was located. It had an uneventful and modestly profitable existence until 1975, when it was taken over by a group led by Bill P. Jennings. ''Beep'' Jennings was an experienced banker of vast geniality and a certain innovative turn of mind. He was also rather unorthodox in his methods, being so impatient of detail that he often committed himself to a large loan without any real investigation, and then had his underlings fork over the money before they could even complete the paperwork; in the process they sometimes ended up without any collateral. Jennings also believed with a truly religious fervor in the oil and gas boom.
A year after he arrived, Jennings started an oil and gas department. At first it was headed by a quite conventional banker, but after he resigned Jennings gave the job to Patterson. Then still in his 20s, Patterson had served an undistinguished apprenticeship at another local bank, where his talents had been so lightly regarded that he never received authority to lend money. Patterson proved a tremendous salesman, however, and also became a sizable investor in the bank.
Zweig's account suggests that Patterson's capers offended a few bankers but hardly interfered with his career. What sent the career into orbit was his development of close relationships with the oil and gas lenders at the big metropolitan banks, which soon included not only Continental Illinois and Seafirst but also Chase Manhattan and Michigan National. It is not unusual, of course, for banks to sell loan participations to one another. Large banks typically ''downstream'' loans to their smaller correspondents, and the correspondents often ''upstream'' loans to the money- center banks. These sales help all involved to diversify their loan portfolios and additionally help the small banks to avoid carrying loans that might seem dangerously large. But for one awkward detail, Patterson's loan sales made eminent sense. For every loan dollar that went upstream, Penn Square collected a service fee. Since it was often originating multimillion-dollar loans and selling off almost all of them, the sales were generating a tremendous fee income for the bank with little risk exposure. The sales also propelled Jennings and Patterson into the banking big time.
Although the bank had only a few million dollars of Capital in the Seventies, and at one point had a legal lending limit of only $400,000 (10% of the Capital), the sales soon enabled them to offer their own customers loans as high as $30 million. These loan sales totaled more than $2 billion by the time the bank went bust.
The awkward detail was that quite a few of the loans were no good. Patterson and Jennings were in the habit of lending on a hope and a promise, and the expectation that energy prices would go up forever; fantasies of $80 or $100 a barrel off in the future were common in their crowd. Morever, collateral was not a problem for Penn Square borrowers.
Zweig notes that the conservative way to lend on oil or gas is to take proved reserves as your collateral, with the loan limited to maybe 50% of reserves. But Patterson was accepting drilling leases, and oil and gas rigs, as collateral on his loans. Unfortunately, leases sometimes become worthless when a few dry wells are sunk in a field, while a rig that cost millions may be nearly worthless when hardly anybody is drilling.
In any case, Penn Square had no desire to foreclose on anyone. To foreclose would require the bank to recognize a ''nonperforming'' loan and thereby reduce profits. In addition, foreclosure would send a signal to the upstream suckers that Penn Square loans were possibly shakier than previously assumed.
So Patterson and Jennings operated on the premise, as Zweig puts it, that ''any problem could be fixed with more money.'' When a customer was in arrears, they would characteristically bail him out with a new and larger loan. This self-deluding Ponzi scheme could be sustained as long as the bank could generate the deposits to underwrite new loans. Right up to the end, it was getting the deposits by offering outsize rates on certificates of deposit, thereby attracting hot money from all over the country.
In retrospect, the failure of the upstream banks to see the unhealthiness of this situation is the most astonishing detail we are left with. Zweig's account tells us that senior management at these banks was not really on top of the energy departments, and the departments themselves were, like Jennings and Patterson, totally committed to a vision of higher energy prices.
Furthermore, there was not always an arm's-length relationship between Penn Square and the upstream banks.
For example, John Lytle of Continental Illinois personally borrowed several hundred thousand dollars from Penn Square while buying millions of dollars of loan participations -- an egregious conflict of interest. Even so, you'd think that the upstreamers would at some point have caught on to the fact that a bank endlessly selling off its loans had less need than other banks to ensure that the loans were solid.
THE REGULATORS' FAILURE to stay abreast of Penn Square seems to have reflected a certain want of imagination. The Comptroller's Dallas office was evidently no match for Patterson. In Zweig's rendering of the tale, the agency assumes a certain amount of rationality on the part of bankers being examined. The Comptroller of the Currency is not really geared up to play detective. And so the Comptroller's examiners, who would routinely be searching for nonperforming loans, might well be flummoxed by somebody like Patterson, who would often sweep problem loans upstream before the examiners arrived -- and then buy them back 30 days later.
Patterson was acquitted last year in an Oklahoma City trial where he stood accused of defrauding Penn Square. (The jury was possibly influenced by the argument that his antics could not have been intended to damage a bank in which he was a stockholder.) However, his troubles are not over: around year- end, he and John Lytle will go on trial in Chicago, this time charged with defrauding Continental Illinois. Belly Up leaves you thinking that nothing quite like the Penn Square fiasco is likely to happen again soon. The event itself was, of course, a trauma for the regulators, not to mention the big money-center banks, and all parties are now presumed to be warily watching for any replays of Bill Patterson's shenanigans. To be sure, the next generation of hotshot young bankers might think of some new ones.