Capital Markets

Cost of Capital, Customer Credit Worry CFOs

Finance chiefs fear the current crisis will have a domino effect on banks, curbing lending to consumers as well as to their own corporations.
Avital Louria Hahn and Kate PlourdSeptember 18, 2008

In the wake of this week’s turmoil on Wall Street — the failure of Lehman Brothers, the bailout of AIG, the sale of Merrill Lynch to Bank of America, and the doubling of the benchmark Libor interest rate — credit markets have tightened beyond their prior noose-like grip. And while the cost of capital to their own companies is their most immediate concern, CFOs outside the financial sector are also worried that their customers are finding it hard to get their hands on enough cash to buy homes or consumer goods.

With liquidity dwindling, finance chiefs are, of course, taking a fresh look at their companies’ existing debt agreements and balance sheets to spot the effects of the shakeout. “More concerning than the fact that there is one or two less investment banks is the fact that banks are clearly continuing to find it difficult to raise capital to repair their balance sheet,” says Paul Farr, CFO of Allentown, Pa.-based PPL Corp., an energy and utility holding company. “And until they repair their balance sheet they can’t provide high-quality credit to their customers.”

The indirect effects on a company can also be anxiety provoking. Comcast’s CFO Michael Angelakis told investors at a Goldman Sachs conference in New York on Wednesday that while the cable giant is generating free cash flow and hasn’t been affected dramatically by the turmoil, “we’re very concerned about the ripple effects it may have on the consumer market,” he said. “It’s more of just a scary world out there, and we’re trying to make sure we’re evaluating whatever risk we have appropriately.”

“Macroeconomic conditions are worrisome,” agrees James Cline, CFO of Trex Company, a publicly traded manufacturer of decking and fencing for homebuilders that has taken in about $310 million in sales in the last year. “If people can’t borrow money on home equity lines or get a direct borrowing on their home there is a potential impact on our sales.”

The fear is bound to be more immediate for a company that’s on the other side of a deal from one of the hard-hit financial giants. Even though the damage PPL has suffered from the turmoil has been limited — it managed to set up a $385 million credit facility last week — Farr is apprehensive about what Lehman’s demise and the Wall Street crisis say about the bigger picture. “When counterparties like a Lehman disappear — if they ultimately disappear — then that is one less counterparty for my trading desk and for other companies to trade with and create market liquidity,” Farr says. “Then there is also the mark-to-market exposure that various companies have with them.”

Those who have actual exposures to Lehman might “wonder how they are going to collect back the collateral and how they are actually going to settle a trade with a company that is in bankruptcy,” he says.

PPL might have to trim the size of its credit facilities by the amount of Lehman’s commitment. Two PPL subsidiaries, PPL Energy Supply and PPL Electric Utilities, have a combined $4.735 billion in credit facilities, of which $185 million represents the share of Lehman Brothers Bank. “If a lender’s commitment becomes unavailable, the aggregate facility commitment will be reduced to the extent such unavailable portion is not replaced by a new commitment from another lender,” the company stated in an 8-K.

PPL is also involved with Lehman via energy trading. The firm’s Lehman Brothers Commodity Services subsidiary served as a counterparty in the trading of energy and fuel with PPL Energy Supply and PPL EnergyPlus. According to the 8-K, the company’s potential loss, however, is not material: As of September 15, PPL EnergyPlus’s direct net exposure was estimated to be less than $2 million, pre-tax.

Farr says he’s comfortable with the banks the company is currently dealing with. The $385 million, 364-day syndicated credit facility PPL raised last week was led by Wachovia and a subset of the bank group participating in the PPL’s $4 billion-plus credit lines. “From all the various financial institutions that have had distress in one form or another, we have not seen any material impact on the outright amount of our credit facilities,” says Farr.

But the finance chief is keeping a close watch on the banks’ health. He also knows that whatever good terms his company is getting now may change when facilities have to be renewed. “I have several multi-year facilities that don’t need to renew in the near term,” he says. “But when these facilities need to be rolled over it will be more expensive.”

Smaller private companies, however, might find rabbit holes where they can avoid the crisis–and even find ways to benefit from it. Tom Berquist, CFO of Ingres Corp., an open-source database company, sees the problems on Wall Street as an opportunity for his company. Even though the tech sector will probably be hurting as the rate of client spending goes down, he believes, there will be a renewed interest in his products, which don’t cost money to license.

And as a private company owned by a private-equity firm, Ingres isn’t immediately affected. “We don’t worry about capital,” he says. Still, everyone is affected by the news in some way, he says. He thinks mergers and acquisitions will be put on hold and that startups, especially early-stage companies, will struggle to get capital.(Sarah Johnson also contributed to this story.)