TESTIMONY OF JOHN W. INGRAHAM, VICE PRESIDENT AND SENIOR OFFICER, CITIBANK, N.A., NEW YORK, N.Y., ON BEHALF OF ROBERT MORRIS ASSOCIATES, THE NATIONAL ASSOCIATION OF BANK LOAN AND CREDIT OFFICERS, ACCOMPANIED BY CHARLES H. POWERS, VICE PRESIDENT, UNITED FEDERAL BANK OF DENVER; GREGORY L. BRENNAN, SENIOR VICE PRESIDENT, THE CHASE MANHATTAN BANK OF NEW YORK; JOHN J. JEROME, ESQ., MILBANK, TWEED, HADLEY & McCLOY, NEW YORK; DAVID L. BLEICH, ESQ., SHEARMAN & STERLING, NEW YORK; AND G. ALEXANDER COLE, SENIOR VICE PRESIDENT, INDUSTRIAL VALLEY BANK OF PHILADELPHIA

Mr. INGRAHAM. Good morning, Mr. Chairman, and thank you. To my left are Mr. Charles H. Powers, vice president, United Bank of Denver; Mr. Gregory L. Brennan, senior vice president of the Chase Manhattan Bank; Mr. John J. Jerome, Milbank, Tweed; and to my right are Mr. G. Alexander Cole, senior vice president of the Industrial Valley Bank of Philadelphia; and Mr. David L. Bleich, of Shearman & Sterling in New York.

The views expressed today will represent a consensus of the members of the Robert Morris Associates Task Force. Robert Morris Associates is an association of over 6,000 bank loan and credit officers who represent about 1,650 banks holding 78 percent of all U.S. commercial banking resources. The association founded in 1914 was named after the American patriot who was a signer to the Declaration of Independence and was largely responsible for financing our Revolutionary War. Subsequently, Robert Morris helped establish a banking system for the new Nation.

The association is essentially educational in its activities and is concerned with sound commercial bank lending practices. Given the current public preoccupation with and misunderstanding of bank loan portfolio problems, there is heightened attention by bankers to the assessment of credit risks on existing and proposed loans. Banks are important suppliers of capital to the Nation's economy. They lend today over $190 billion of funds to commercial and industrial firms. on both a secured and an unsecured basis.

The Robert Morris Associates is opposed to enactment of either H.R. 31, the Commission bill, or H.R. 32, the Judges bill, in their present form, and we are specifically opposed to the proposed legislation in the following areas:

1. The role of the administrator in corporate reorganizations.

2. The replacement of the flexibility of chapter XI by the proposed chapter VII.

3. The use of property subject to liens.

4. Setoff and use of property subject to right of setoff.

5. Extensions of credit to debtors or trustees.

6. Creditors and equity security holders' committees.

7. Voidable preferences.

Bank lending officers are deeply concerned that some of the changes proposed to be made in the bankruptcy laws, as they affect commercial

bank lending, will adversely affect the willingness or ability of banks to undertake certain types of risks.

Indeed, the proposed changes are likely to affect the risk preferences of a much larger class of lenders than just commercial bankers. Mortgage lenders, insurance companies, factors and pension funds stand out immediately as creditors whose willingness to undertake risk would be substantially diminished by the current proposals.

To the extent that a large class of creditors take a significantly more cautious posture with respect to risk the allocation of capital to certain segments of industry with great needs, such as small businessmen, will be seriously impaired.

Because of this danger, it is essential that the already weak position of secured creditors not be further eroded as now contemplated. To buttress our view, permit me to step back from legal and technical details to examine the proposals from a broader perspective. The primary thrust of my comments will be directed toward chapter VII of the Commission bill providing for reorganization of business debtors.

I am not going to read the full statement. What I would like to do would be to read selected paragraphs which I would like to use for emphasis during my testimony at this time.

The first paragraph I would like to emphasize would be on page 2 in the area from an economic perspective.

Bankruptcy is one of the economic processes by which less efficient users of resources move out of the marketplace, thereby making resources available for more innovative and efficient firms. At the same time, providing to debtors a reasonable opportunity to salvage their investment and reestablish where possible an efficient and ongoing concern through the mechanism of a rehabilitation proceeding under the bankruptcy laws is a principle with which we find no fault.

I would like to then go on to page 3 starting about half way through. The proposed bills would retard institutional lending through their effect on lenders' attitudes toward risk. Any investment decision involves risk-the risk that the business will fail and the investor will lose the funds he has invested.

For example, a major element in an investor's determination of the return required on a given investment-whether in interest or dividend payments or capital appreciation-is the risk he is undertaking and for which he should be compensated.

It is the risk differential which explains the fact that Treasury bills-full faith and credit obligations of the U.S. Government-may be sold at lower interest rates than commercial paper-unsecured notes of large corporations-of identical maturities.

In an effort to minimize risk many longer term loans to industrial corporations include a provision providing collateral security for the lender against which recovery might be made should the borrower fail to perform. The existence of this collateral is often the critical factor in the decision to make a loan to a high risk borrower. In addition, the presence of a security provision may result in a slightly lower interest rate to a more creditworthy borrower.

For prime borrowers, the impact of the enactment of either the Commission bill or the Judges bill is likely to be minimal in terms of either cost or availability of funds. But for lower grade borrowers,

the proposed laws may amount to a virtual kiss of death. Despite a lender's reluctance to enforce security provisions, the existence of collateral does offset a portion of the risk associated with any loan.

Where the risk that the borrower may go into default-because, for example, the firm's product does not achieve sufficient market penetration is higher than the lender prefers, the existence of the security provision may be the only condition under which the lender will be willing to make the loan.

In other words, for some borowers there may be no rate of interest which will compensate the lender enough to persuade him to undertake the desired financing on an unsecured basis or on a basis where the likely inability to recover on collateral makes the lender little better off than if he were unsecured.

The proposed bills, making it easier for a marginal businessman to maintain his firm under conditions of financial stress by assuring that ailing firms will have a second chance may be counterproductive of the very thing they are trying to accomplish.

Creditors generally will give a borrower a second chance if there is any reasonable likelihood of success. However, a law that gives all distressed firms the ability to tie up collateral in a failing business, regardless of the likelihood of successful reorganization, risks a massive waste of resources.

Even if we assume that all debtors ought to have a second chance, the actual impact of enactment of the proposed legislation, insofar as it causes institutions to adopt more stringent lending standards, may be to prevent them from ever getting the first chance.

A substantial number of the loans made to smaller firms with lower credit ratings are made only on a fully secured basis. Lenders who have, in the past, agreed to make loans only on a fully secured basis are unlikely to make loans that are considerably less secured.

Moreover, the diminution of the rights of secured lenders is unlikely to stimulate a new class of lenders to step up since unsecured creditors still may recover only after satisfaction of more senior secured claims.

Thus for many firms, access to credit markets will diminish appreciably and the risk premium charged will in all likelihood increase. to compensate for losses.

I would like to go to page 9 and review for a minute the charts. This is in connection with the historical perspective. Looking at figure 1 on page 9, the number of business failures is apparently below that of the early 1960's and continues to conform to the business cycle.

In figure 2, the ratio of business failures to new corporations has dropped over the past 18 years, reflecting the fact that the U.S. economic environment still favors the growth of business formation. On the next page, figure 3 indicates that the vast majority of bankruptcies are nonbusiness cases as you all are quite aware of.

On figure 4. it shows that the nominal liabilities of business failures have grown but have remained at constant proportion of gross national product.

The last is figure 5, the major cause of business failures continues to center around managerial competence. Going back to page 5 for a minute.