Capital Markets

The Standoff Continues

As banks and companies hoard their cash, credit remains extremely tight. That's forcing CFOs to explore new (and old) options.
Russ BanhamMarch 1, 2009

In the global pursuit of credit, few CFOs are as fortunate as Holly Koeppel. The finance chief of American Electric Power, one of the nation’s largest generators of electricity (and consumers of credit), Koeppel has access to several lines of credit totaling $4 billion, provided by a consortium of 28 domestic and international banks. When the commercial-paper market dried up last fall, hampering AEP’s ability to raise near-term cash, Koeppel drew $2 billion from the facility, banked the cash, and gradually retired the commercial paper. “That was our bridge to get us through the end of the year so we could stay out of the long-term credit market when it was roiling,” she says. When the seas calmed temporarily in January, the utility waded back into the credit markets with a successful bond offering at 7 percent, a remarkably reasonable rate.

Koeppel concedes a degree of luck in her credit arrangements. A company far more emblematic of the times is FlexSol Packaging, a privately held $250 million maker of packaging and films for food and beverage companies. FlexSol used to enjoy unfettered entrée to traditional working-capital lenders that were only too happy to finance its equipment needs. “I’d access capital through leasing groups like General Electric or Merrill Lynch, which had a big leasing arm,” says CFO David Schaefer. Lenders were so eager, in fact, that Schaefer often got 15 solicitations a week. These days, not so much. “I get no calls now from cash-flow lenders,” he says. “It has affected our ability to undertake acquisitions or do much in the way of capital expenditures.”

Most U.S. companies, especially non-investment-grade firms, are similarly constrained as they search for ways to obtain credit and refinance or extend debt facilities. CFOs with bank and capital-market debt maturing over the next two years — more than $700 billion in loans come due in 2009 alone, says Standard & Poor’s — in particular are trying to buy time. Even those with credit agreements extending beyond 2010 face possible reductions in the amounts they can borrow. In February, the Federal Reserve reported that many banks had reduced the dollar limit on existing lines of credit — 50 percent did so on credit lines extended to financial institutions, 30 percent on business credit-card accounts, and 25 percent on commercial and industrial credits. Heaping insult upon misery, some banks are selectively dropping out of lending syndicates.

“We’re working with a lot of banks that have exited facilities because either they no longer find them profitable at improved pricing or they have liquidity or capital constraints and have to prioritize who they want as a customer,” says John Walenta, director of the corporate and institutional banking practice at Oliver Wyman. Walenta cites European banks as taking “an especially harder look” (see “A World of Trouble“).

There are no magic answers to the continuing problem of how to finance projects, acquisitions, and equipment under current conditions. Well, maybe one: some companies have opted out of the hunt altogether. Having cut plant, equipment, and inventories, their capital needs have shrunk dramatically. Indeed, 60 percent of domestic and foreign banks reported a reduction in demand for commercial and industrial loans during the fourth quarter, according to the Federal Reserve.

But if a company doesn’t want to sit out this economy, and does not view a splashy equity offering or a liquidation of noncore assets as appealing options, there are other viable approaches. To be sure, they occupy spaces considerably far down the standard checklist of techniques, but they may merit a closer look. In particular, adding smaller regional domestic or international banks as partners, issuing securities with more esoteric methods, and freeing up capital by running tighter operations all deserve close consideration. CFOs will have to balance those options against the longer-term need to position their companies as better credit risks, which is a delicate act to pull off. None of these solutions is right for every company, but each one may provide at least a partial solution for companies that proceed carefully.

Say Hello to Your New Banker

If they haven’t already, CFOs trying to corral capital can turn to foreign banks and smaller, regional U.S. banks that have sturdy balance sheets. Adding more banks to a revolver, for example, can reduce a company’s exposure to, and reliance on, any one bank. “CFOs called on in the past by second-tier European and Asian banks interested in joining their lending facilities might want to call them back,” says Walenta. As a group, he notes, Japanese bankers are looking to increase their presence in the United States, as are banks from Singapore and Korea. “These are potential pools of liquidity that U.S. multinationals [in particular] can tap into,” says Walenta.

Paul Reilly, CFO of Arrow Electronics, a BBB-rated global distributor of electronic components, has been approached by several international banks that want to join the company’s revolving-credit facility. “It’s a great comfort factor for us in that they understand that our business model is to generate more cash in an economic downturn, and they are willing to work with us,” he says. For the time being, though, Arrow is sticking with its current banks.

The time may also be right to reach out to smaller banks. “Why leave your cash-management business with a large bank that won’t lend you money, when there are smaller players that can string together a day-to-day operating line for you?” asks Charlene Davidson, senior managing director at McGladrey Capital Markets, a boutique investment bank. “Your cost of borrowing has skyrocketed, the lender doesn’t seem to be able to make timely decisions, the amount of documentation and due diligence to get a loan are onerous, and now the bank has just fired your relationship manager. It’s time to uncover opportunities elsewhere.” Davidson touts several regional banks, including Wells Fargo, Comerica, and US Bancorp, as less affected by the subprime crisis and “still having their wits about them.”

For some companies, of course, second-tier banks don’t fit the bill. At $5.9 billion Corning, for example, finance prefers dealing exclusively with large global institutions that provide an array of services, such as trade finance, equity issuance, and project finance. “We dissuade our local controllers and finance managers from engaging too much with local financial institutions,” says treasurer Mark Rogus.

The bond market opens to investment-grade companies, but shuns junk-rated issuers.

A less conventional tactic is to raise capital with “at-the-market” offerings of equity securities. Such transactions occur at other than a fixed price and are low-profile. In the prospectus, the issuer usually announces it will be selling a certain amount over a given time period or “from time to time.” This precludes the situation where a company announces it is going to sell x amount of stock in a one-time transaction for a set price, and then comes up short. That could damage a company’s chances of raising any kind of capital, says Steven Kolyer, partner and head of structured capital-markets products at international law firm Clifford Chance LLP. By executing an at-the-market offering, the issuer lowers the risk of perceived failure if it doesn’t achieve a stated goal.

Publicly traded Solarfun Power Holdings, a Shanghai-based maker of photovoltaic cells and silicon ingots, recently completed an at-the-market offering that raised $72 million, earmarked for capital expenditures on new manufacturing equipment. Toward the close of 2008, at-the-market offerings also were made by UAL Corp., which hopes to sell $200 million in newly issued common stock, and Chesapeake Energy Corp., which is offering up to $1 billion as it looks to raise cash for drilling and exploration projects.

Tidying Up

When credit dries up it becomes a good time for companies to turn their gaze inward, seeking opportunities to cut capital consumption and deploy assets more efficiently. Arrow Electronics has a $1.4 billion multibank lending syndicate that CFO Reilly hasn’t borrowed from for several quarters. “We’ve been cash-flow positive for five years and have been able to prepay our debt before it comes due,” Reilly explains. Still, Arrow continues to improve inventory management to save capital. “We’re reducing the amount of inventory that sells slowly, and are working more closely with customers to find out just how much inventory from us they actually need,” Reilly says. “The less inventory, the more cash and liquidity we have.”

Michael Kramer, former CFO of Abercrombie & Fitch and newly appointed CEO of apparel maker and distributor Kellwood, with $1 billion in revenue and brands like XOXO and Baby Phat, says, “It’s back to business fundamentals, hunkering down and living within your means. It’s so important — critical, really — to have substantial cash reserves and not overleverage.”

Instead of turning to the credit markets, Kramer is extending payment terms with some vendors, while shortening them with customers. “There needs to be a level of partnership through the verticality of channels like never before,” he explains. “The days are over for a company to run its business to the edge.” Kramer is willing to lend money to vendors in difficult cash positions, given their strategic value. In other cases he will pay upfront in return for a 2 percent discount. “The last thing you want is to push them into bankruptcy,” he says.

The Great Divide
In the years ahead, a larger problem will confront companies: how (and whether) to maintain or even improve their credit rating. It’s clear that banks and bond markets have reinstituted “the great divide” of corporate creditworthiness. While investment-grade companies like AEP can negotiate fairly decent pricing, terms, and conditions for short-term and long-term debt, those with poorer credit ratings either have the door slammed in their face or must swallow the bitter pill of very expensive interest rates. “There is a definite dichotomy between healthy, investment-grade U.S. multinationals that have solid balance sheets and the ability to access credit, and those that fall slightly under that line of demarcation,” says Sandy Cockrell, national managing partner of the CFO program at Deloitte LLP.

Lenders are competing for “slam-dunk” credits, those with plenty of assets and cash flow to cover debt service, explains Daniel G. Berick, an attorney at Squire, Sanders & Dempsey. Meanwhile, for most borrowers, Berick says the credit, asset-review, and due-diligence processes are “significantly protracted.” While the bond market has had a bit of a resurgence, it also is a recourse solely to very healthy, highly rated companies. If you’re not in that club, “you’re shut out,” Cockrell asserts, “unless you want to resort to extremely expensive non-investment-grade public financing that is virtually prohibitive insofar as terms, conditions, and rates.”

While it is too late to rebuild a company’s credit rating for the current crisis, CFOs of non-investment-grade companies should consider developing a long-term plan for transforming the company into an attractive credit. In general, that involves maintaining a more conservative financial profile by raising the headroom under performance covenants in bank agreements, improving liquidity, keeping leverage to a minimum, and similar tactics.

Those are not moves every CFO wants to make, but they paid off for Corning. When the bursting of the telecommunications equipment market in 2001 crushed Corning’s optical-fiber business and forced the company to exit photonics, it rewrote its balance sheet to reflect a more conservative capital structure. “We decided to have a modest amount of long-term debt and an overabundance of liquidity or cash,” says treasurer Rogus. “It took a few years to accomplish, but we entered 2006 with a capital structure of $3.5 billion to $4 billion in cash and $1.5 billion to $2 billion in long-term debt.” Corning’s senior debt fell to a Moody’s rating of Ba2 in 2002, but by 2007 it had been upgraded three notches, to Baa1, an investment-grade rating. It didn’t hurt that Corning retooled for the upswing in the market for liquid-crystal-display glass, used in flat-screen televisions and computers.

Many CFOs would be happy to have three years of breathing room before any debt matures, as Rogus does, but Rogus is already thinking about strategy and choices should the recession linger beyond 2010. “If the credit markets haven’t improved by then, we will have to go back and renegotiate with the banks, at what will likely be more-expensive rates and more-restrictive terms and conditions,” he says.

Even AEP’s Koeppel doesn’t like what she sees when she takes the long view. “Accessing credit at a predictable price — I don’t expect to see those days for quite some time,” she says. “Nevertheless, our ability to move early in drawing on our lines of credit has benefited us, giving us the flexibility to wait out the current crisis to resume more normal refinancing. That said, I am not relying on any one strategy going forward. I’m looking at all financing options. It’s what every CFO should be doing.”

Russ Banham is a contributing editor of CFO.

Be the Bank

If you’re not happy with your bank, how about opening one of your own? It’s not as far-fetched as it sounds. In theory, “a company can do it if it makes a strong enough case,” argues Steven Kolyer, partner and head of structured capital-markets products at international law firm Clifford Chance LLP. Target and Harley-Davidson, for example, both run industrial loan corporations, a kind of state-chartered bank sanctioned by the state of Utah. “You can access potentially billions of dollars from depositors that are federally insured up to $250,000 per depositor. The Federal Reserve is flooded with bank-holding-company applications from companies that are not banks,” Kolyer says.

While just two years ago federal regulators and Congress were blocking commercial companies from moving into banking, they appear to have modified their stance. American Express, CIT, and GMAC are among the companies that recently converted to bank holding companies, primarily so they could participate in the government bailout.

Last year the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency relaxed the rules for investors looking to buy troubled financial institutions. Such groups can get a new type of national bank “self charter” before actually buying a bank. The self-charter allows investors to, among other things, view the FDIC’s confidential list of troubled and failing institutions and bid on them.

Opening a bank isn’t as easy as opening a checking account, of course. Expect regulators to comb through the proposed management team, the sources and amount of capital that would be available, and the business plan. “Bank holding companies and their affiliates will now be under the watchful eye of the Federal Reserve,” explains Ernie Patrikis, a partner in the bank and insurance regulatory practice at White & Case. “These new companies will quickly need to learn how to live in the bank supervisory world and implement new risk-management practices to ensure compliance across a wide range of banking regulations and supervisory guidelines.”

That’s a big headache most CFOs could do without, but for a select few the best way to beat the bankers may be to join them. — R.B.