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Bank credit is easy, maybe too easy. Don't pass it up.
Randy Myers, CFO Magazine
April 1, 2006
Barnes Group Inc. isn't used to being fawned over by banks.
The $1 billion manufacturer of jet-engine components and engineered springs doesn't even have a credit rating, though CFO William Denninger guesses it would rank at just about the bottom of the investment-grade barrel, BBB or BBB-, if the company went to the expense of buying one.
Nonetheless, Denninger has seen what life must be like with a gilt-edged balance sheet. Early this year, he watched Barnes's treasurer, Lawrence O'Brien, emerge from a meeting with the company's 11-lender bank group with a host of improvements to the company's $175 million credit revolver. O'Brien was able to negotiate a 25-basis-point decrease in the borrowing rate, while carrying over a previously negotiated accordion feature that allows the Bristol, Connecticut-based company to raise up to $75 million of new bank commitments under the existing facility. He was able to extend the revolver's maturity by almost 20 months — putting it back to a full five-year term — and increase the company's overall borrowing limit to 4 times EBITDA from 3.25 times.
For good measure, O'Brien also won approval for his company's new international Swiss holding company to borrow directly against the revolver. Some in Barnes's bank group don't often venture offshore, notes Denninger, but extending borrowing authority to the Swiss entity made so much sense for Barnes that the bankers allowed it. "Right now, virtually all of our debt is in the United States, but we generate the majority of our cash in our offshore operations and can't use that cash to pay down the debt in the U.S.," he says. "This will allow us to borrow offshore, where we generate our cash, and therefore use that cash to pay down those borrowings." (For a look at the tax considerations of using foreign assets as loan collateral, see "Deemed If You Don't.")
Beating the Borrowing Bushes
Barnes is far from alone in finding lenders to be generous these days. Healthy profits have companies and their lenders around the globe awash in cash. Fitch Ratings recently surveyed 500 U.S. industrial companies with credit ratings ranging from A to BB — the very middle of the market — and found that, on average, they had twice as much cash on their balance sheets as short-term debt, up from a ratio of 0.5 to 1 in 2000. CFOs insist they aren't saving for a rainy day, but cash hasn't exactly been pouring out of corporate coffers. Until the latter half of last year, merger-and-acquisition activity was moderate, and capital-expenditure outlays haven't been extraordinary either. With companies so flush, it's not surprising that since 2004, banks have been beating the bushes for customers and offering enticing terms to win their business.
"Everybody's looking for funded assets," says Joseph Chinnici, managing director and head of debt-capital markets for KeyBanc Capital Markets, referring to bank loans and actual borrowings against credit revolvers. Many if not most investment-grade companies take out a credit revolver but never borrow against it, so the banks make little or no money on it. "There is too much liquidity chasing too few dollars," says Chinnici. Exacerbating the situation, new lenders, including insurance companies and hedge funds, have come wading into the market, making competition for business all that much keener. "When a [credit] facility does become available where it would be drawn or utilized," he adds, "banks just fall all over themselves to get involved." Confirms Helen Shan, vice president and treasurer of investment-grade $5 billion postage-services company Pitney Bowes Inc., in Stamford, Connecticut, "We have more banks wanting to give us credit than we necessarily want or need."
To their credit — or eventual chagrin, should it turn out that they've been too aggressive — banks have been successful at whipping up business. Reuters Loan Pricing Corp., which tracks and analyzes global credit markets, reports that U.S. loan issuance, including revolvers, hit a record $1.5 trillion last year. That included a record $500 billion–plus in leveraged (non-investment-grade) lending and a second-highest-ever $669 billion in investment-grade lending. Among the incentives banks offered to make that happen: low prices. Tim Houlahan of Wells Fargo Syndications and head of origination and structuring for the U.S. corporate banking segment, says average loan pricing in the BBB market was down about 40 percent from 2003, driven in part by strong lender demand for funded assets and low default rates. Price declines weren't as dramatic for higher investment-grade borrowers, in part because many of these facilities are established to back up commercial-paper issuance and have historically been tightly priced. Meanwhile, banks have been willing to extend credit for longer terms. In 2002, Houlahan says, about 70 percent of syndicated loan volume was issued on a 364-day basis; now, less than 10 percent of loan volume is issued for that term. Five-year terms are readily available for both investment-grade and leveraged borrowers, and some banks have even offered six- or seven-year terms for some clients.
Debt-market analysts credit all this easy money for keeping the high-yield bond market frothy and high-yield default rates modest. According to Mariarosa Verde, managing director of credit market research for Fitch Ratings, 20.5 percent of the debt issued in the high-yield bond market last year was floated by companies with non-investment-grade ratings of C, CC, or CCC, the lowest ratings Fitch assigns for anything other than bonds that have already defaulted. By contrast, companies with such dire ratings accounted for only 10.1 percent of new high-yield issuance as recently as 2003. Still, with corporations able to feed at the bank-credit trough, high-yield default rates remain low. Verde says only 1.5 percent of the market defaulted in 2004, by volume, and only 3.1 percent in 2005, down from 16.4 percent as recently as 2002.
How Long Can It Last?
The key question, of course, is how long can these good times roll? To a large degree, it depends on the economy. As long as GDP growth remains strong, corporate profits should follow suit and this credit utopia should be able to extend its run. Many economists expect GDP to show solid growth again this year, albeit down a shade from last year's 3.5 percent clip. Credit analysts and corporate borrowers alike suggest that, absent some dramatic event — a major terrorist attack, say, or an iconic U.S. company defaulting on its debt — the bank-credit spigot should remain wide open at least through the remainder of this year. Even the Federal Reserve's campaign to raise short-term interest rates isn't expected to have too much impact on the demand for or availability of bank credit (see "The Fed on the High Wire" at the end of this article). "For this kind of lending, the absolute level of interest rates is probably not a big determinant of activity," says Brad Hardy of Wells Fargo. "Most clients need the backup facilities and access to liquidity, so they will put something together regardless of rates."
That said, GDP may not be a good leading indicator of credit conditions. After that period of easy credit cited above, for example, GDP growth continued to be strong in 1999, dipped just a bit in 2000, and didn't slump with any drama until 2001 — well after bankers began tightening their lending programs. Industrial production, by contrast, peaked in 1997, comfortably preceding not only the tightening of the bank-credit market but also default rates in the U.S. high-yield bond market (see "As Goes Growth" at the end of this article).
Other developments that could signal a tightening of the bank-credit market would be a slowdown in either consumer or business spending or a sharp decline in the housing market. Consumers have been driving the economy for some time now, but they may be tapped out. Wage growth won't pick up without stronger employment trends, and those won't rise unless business spending does. The Commerce Department recently reported that construction of new housing units fell 8.9 percent in December, leading some economists to predict that the torrid growth there is now behind us.
Some credit analysts also suspect that if there is an uptick in defaults in the high-yield bond market this year, banks could become more leery of lending; others argue that bankers, being closer to borrowers than bondholders, would begin tightening even before that happened. The former group has undoubtedly noticed that even though the high-yield default rate remained low in 2005, it was twice the rate of 2004. Also, Fitch reports that during 2005, the volume of defaulted debt bottomed out in the second quarter, then grew in both the third and fourth quarters.
Much depends on the concerns of bank regulators, particularly at the Office of the Comptroller of the Currency, Martin Fridson, CEO of FridsonVision, an independent research firm, told a recent Standard & Poor's conference on credit. At present, Fridson said, the regulators are "clearly more concerned" about mortgages than corporate loans. He said he expected that eventually to change, "though [the new policy] won't be published when the change occurs." For now, though, lenders aren't expecting anything to slow the bank-credit market in 2006. Meredith Coffey, director of analysis at Reuters Loan Pricing, says lenders surveyed by her organization expect loan volume this year to outpace last year's record levels.
Seize the Day
Like last year, look for much of the borrowing demand this year to come from refinancing of existing debt. Despite a late surge in borrowing-fueled M&A activity, nearly two-thirds of all borrowing last year came from companies like Barnes Group that were taking advantage of market conditions to lock in favorable terms and, in some cases, bigger lines of credit. BBB-rated Sealed Air Corp., for instance, put a three-year, $350 million credit revolver in place in 2003. Last June, the $4.1 billion packaging-products company refinanced early, boosting the revolver to $500 million and extending the maturity to five years. The Saddle Brook, New Jersey–based company also refinanced a syndicated facility in Australia and New Zealand. Treasurer Tod Christie says he was able to negotiate a loosening of the covenants on the company's revolver, a lower facility fee (the fee paid simply to maintain the revolver), and a lower spread against LIBOR on any funds it actually borrows under the revolver.
Given their sanguine outlook, it's lenders who urge CFOs and treasurers who haven't already refinanced this year to jump on the bandwagon before it leaves town. "My assessment is that we are probably at or very close to the top of the market from a borrower's perspective," says Wells Fargo's Houlahan. "There's little room for banks to reduce pricing or provide greater flexibility or more-attractive structural terms. Anyone who hasn't done a five-year deal by now is probably remiss." In short, why push your luck?
Brad Hardy suggests that companies also take the pulse of their bank group and assess whether individual members are getting adequate compensation, in the form of other, more lucrative business, for the low-margin credit they are offering. "If banks feel they are getting an adequate return, then when the market tightens up, they're more likely to stick around and stay supportive."
The bank credit market doesn't get any better than this.
Randy Myers is a contributing editor at CFO.
The Fed on the High Wire
How long can the Fed raise rates without triggering a credit crunch?
In three prior Fed tightening periods — 1988, 1994, and 1999 — companies actually borrowed more, not less, than they had in the prior year, by an average annualized rate of 6 percent, according to an article published in late 2004 in AFP Exchange magazine, by a trio of Citigroup executives.
Certainly, there is precedent for easy credit conditions lasting longer than two years. The Federal Reserve's quarterly Senior Loan Officer Opinion Survey shows that during the five-and-half years from 1993 to mid-1998, for example, banks steadily loosened standards for commercial and industrial loans. Not coincidentally, that period correlated with steady and robust economic growth (see "As Low as They Can Go?" at the end of this article). — R.M.