VideoFADE IN: a bankruptcy court in downtown Manhattan, late January, minutes before the close of business. The equity markets have taken a nosedive, and nervous bankers are putting pressure on executives of Quebecor World, and Judge James Peck. The commercial-printing company is just days away from running out of cash. One of a team of lawyers sprints in with a document detailing $750 million in debtor-in-possession financing for the company. Quebecor World attorneys ask for an extra 15 minutes to review the 40-page agreement. Nothing doing, say lawyers for the company's lenders. You have until 5 P.M.
Welcome to the new rough-and-tumble world of corporate finance, where banks' markedly different posture on lending money is affecting businesses of all stripes — not just those in default.
During the last quarter of 2007, one-third of banks hardened credit standards for midsize and large businesses, according to the Federal Reserve's senior loan officer survey, and two-fifths increased loan spreads over their cost of funds. Not one of 56 eased standards. The January numbers are the highest since the first quarter of 2002, when 45 percent of banks tightened terms and conditions.
CFOs have run this gauntlet before — higher financing costs, choosier lenders, the scramble to renew loans ahead of further market souring. But in the last credit crunch, in 2001, high corporate default rates and fraud spurred the retrenchment. This time, the problems have arisen within the financial sector itself, making this market contraction fundamentally different.
"The crunch today resulted from poor lending decisions," and that has been exacerbated by the securitization of the loans, says Coleen Pantalone, associate professor of finance at Northeastern University. In other words, banks have structural issues to work through. So they will be even more cautious than they were seven years ago, she says, especially with non-investment-grade credits. But it also means CFOs have to start taking a hard look at the financial conditions of banks, to protect their options for accessing capital.
The Big Pullback
What makes this credit crunch more severe than the one following the dot-com bubble is the dramatic turnabout from the days of easy-to-access credit. Prior to 2001, banks had been in credit-tightening mode for 9 straight quarters. Banks then pulled back drastically the next 10 quarters. But prior to 2008, banks had been easing or remaining neutral on commercial and industrial loan underwriting for almost four years. That suggests corporations have a lot of sweating to do before the credit markets find some kind of historical equilibrium. Indeed, more than 83 percent of bankers expect the quality of business and commercial real estate loans to weaken in the months ahead, according to the Fed.
"CFOs need to recognize that spreads will tighten and loan sizes may have to decrease, as the funds from nonbank lenders simply aren't there," says Meredith Coffey, director of analysis at Reuters Loan Pricing Corp. Companies may be constrained from borrowing to invest in their businesses or to conduct merger-and-acquisition transactions.
Banks are capital-constrained as well, driving them to shorten commercial loan terms. This year, banks will curtail origination of five-year loans, for example, to reduce risk and avoid having to carry the high level of regulatory capital they require — 50 percent, Coffey says. Instead, they will prefer lower-risk, 364-day maturities, which require only 20 percent regulatory capital. To CFOs, it means annual trips to visit their banks to prove they deserve funding — not an ideal situation in a credit environment that is weakening.
Non-investment-grade companies may have trouble corralling any funds at all. Skittishness has plagued the secondary market for leveraged loans, where banks sell corporate debt to investors such as hedge funds. The spread for such loans lingered in the 400-basis-point range in early 2008, and bidders were buying them at more than a 10 percent discount to par value, according to Reuters LPC. But banks would rather hold such loans on their books than unload them at that price. "If no one will buy loans — even perfectly good loans — the market gets stuck," Coffey says.
There is still plenty of demand for investment-grade credits, however, as evidenced by the fact that their spreads "are not blowing out," says James Malick, a principal in the New York office of Boston Consulting Group (BCG). "But the junk is frozen."
"A lot of banks essentially are off the playing field," is how David Lifschitz, executive vice president and CFO of Gehr Enterprises, sums it up. "They are licking their wounds and regrouping."
Collateral Damage
Within banking, the reach of this credit crisis is also longer. So far, the upheaval at U.S. financial institutions has hit businesses tied to housing the hardest. But now commercial-property investors are feeling the pain. Real estate and residential construction lenders such as $52.9 billion (in assets) Zions Bancorp are "being extremely cautious," says Clark Hinckley, a senior vice president at the Salt Lake City–based bank. Zions's nonperforming assets have tripled in nine months. Overall, commercial real estate lenders will lose as much as $180 billion over the next few years, says Goldman Sachs analyst James Fotheringham, in part because of a 20 percent–plus drop in property values.
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