You Can Run But You Can’t Hide

Finance chiefs around the world agree that credit is hard to come by and there is little relief in sight.
Tim Burke and Jason KaraianMarch 2, 2009

The recession gives finance chiefs a lot more to fret over than the plight of banks, yet it’s impossible to ignore such a vital pillar of the economy, particularly when it is under extreme duress and governments’ efforts to help have so far been ineffectual, or worse. But CFOs have to keep their businesses running and can’t wait around for banks to be rescued and reformed by regulators. Few, if any, of the CFOs we spoke to for this special section-in Europe, the US and Asia-are taking a wait-and-see approach. Whether they work in manufacturing, services, utilities, distribution, or even banking, they are focused on what they can do today and tomorrow to get business back on track.

All Stuart Hall wanted was a quiet drink. The CFO of Pace, a Yorkshire-based maker of digital TV set-top boxes, was relaxing in a hotel bar in Hong Kong late one nigh last October, having spent the day studying Chinese acquisition targets. Then his phone rang. It was a colleague in the UK, calling to tell him of rumours that British banks, already in meltdown, might soon be partially nationalised. “I thought that when I got back I’d see tumbleweeds flying down the street and buildings collapsed, like something out of Mad Max,” he recalls.

Yet it was the breaking news outside the UK that really concerned Hall, specifically the unfolding crisis in Iceland, where Landsbanki had entered receivership and had its UK assets frozen by the British government.

That was a problem for Pace, which had been using a $48 million (€38 billion) asset-backed lending facility from Landsbanki Commercial Finance, a UK-based arm of the Icelandic bank.

Fortunately, Hall had prepared for a moment like this. Ever since Pace paid €95m to acquire Philips’s set-top box business at the end of 2007, the finance chief had wanted to bring in joint bankers. After all, he reasoned, the company would double its revenue thanks to the acquisition.

But striking up a relationship with another financier was easier said than done. Despite agreeing with Landsbanki that it could bring in another bank, Pace found the demands of integrating the acquisition too much, and did not sign agreements with any other banks. But it did keep talking to them, which meant that when the line with Landsbanki was pulled, Pace could immediately sit down with three domestic banks to discuss a replacement facility. Indeed, the company ended up with three offers from UK banks, including a £35m (€39m) revolving-credit facility from Royal Bank of Scotland (RBS), its existing clearing bank, which it signed in December.

So everything worked out fine, right? Not quite. Even though Hall says Pace has a good arrangement with RBS-the credit line is cheaper than many he has come across-getting there was tortuous, and constraining. “I have companies in Latin America, America, Malaysia, Hong Kong, China, France, Spain, Belgium,” Hall says. “Every company is its own legal entity. The bank wants to tie you down all over the world with security. That whole process is very, very difficult and doesn’t give you any flexibility. You’ve got to get the bank’s permission for so much.”

And yet Pace may be luckier than other companies. A December survey of UK firms found that banks had withdrawn unused credit lines from a third of respondents’ companies, and more than half said they did not expect to be able to renew current credit lines in full over the following 12 months.

Klaus Kremers, restructuring and turnaround partner at Roland Berger Strategy Consultants, which conducted the survey, confirmed that “credit is being progressively eroded as the crisis continues.” He predicts some “serious casualties” among UK businesses throughout 2009.

Across the Channel, Jean-Claude Suquet, CFO of Paris-based Carbone Lorraine, a €731m advanced-materials and electrical-equipment firm, agrees the situation is deteriorating. He successfully renegotiated a syndicated loan last summer, months ahead of schedule, in response to what he saw as “the bank situation worsening quarter after quarter.”

Intent on pursuing a growth strategy for its carbon products, which are a key component of solar-energy systems, the company struggled to find a solution. “Issuing new shares would be too dilutive,” Suquet says, “because our price has gone down by 40% since September.”

Instead, the company opted for an approach it had discussed years before with its key bank, Société Générale, but never implemented. Described as a “step-up equity facility,” it is a two-year line of credit that Carbone Lorraine may or may not use. If it does choose to exercise it, the company will issue new shares to the bank based on the prevailing price at the time. This means the bank shares some upside if the company’s share price rises, but also absorbs some risk, as evidenced by the fact that the terms allow for a 10% discount on the newly issued shares. Worth up to €75m, or a maximum of 17.5% of the company’s share capital, the facility is adequate for Carbone Lorraine today, and Suquet adds that, “if within six months or a year the market is less volatile and the risk is less for Société Générale, I can call and discuss a new, lower discount. It’s very flexible.”

Like Pace’s Hall, Suquet was in a fortunate position, as banking relationships forged when business was better meant the company had alternatives to turn to when the going got tough. But while forward-­looking CFOs are proving they can tap new funds even in today’s dire circumstances, the broader outlook for Europe’s companies is less cheery. After the “near-closure of the capital markets and a collapse in confidence” following Lehman Brothers’s bankruptcy last year, Moody’s, a ratings agency, claims the scarcity and high cost of funding will continue to be the biggest challenge faced by companies in most industries this year.

Across the pond
In the global pursuit of credit, few CFOs are as fortunate as Holly Koeppel. As finance chief of American Electric Power, one of the US’s largest electricity generators (and consumers of credit), Koeppel has access to several lines of credit totalling $4 billion, provided by a consortium of 28 domestic and foreign banks. When the commercial-paper market dried up last autumn, hampering AEP’s ability to raise short-term cash, Koeppel drew $2 billion from the facility, banked the cash and 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 for a bit in January, AEP waded back into the credit markets with a bond offering at 7%, a remarkably reasonable rate.

Koeppel concedes there was a degree of luck in her credit arrangements. A US company far more emblematic of the times is FlexSol Packaging, a privately held, $250m maker of packaging and films for food and drink companies. FlexSol used to enjoy unfettered access to traditional working-capital lenders only too happy to finance its equipment needs. “I’d access capital through leasing groups like General Electric or Merrill Lynch,” says CFO David Schaefer. Lenders were so eager, in fact, that Schaefer often got 15 solicitations a week. But times have changed. “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 US companies, especially non-investment-grade firms, are similarly constrained as they search for ways to obtain credit, and refinance or extend debt facilities. In particular, 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-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% did so on credit lines extended to financial institutions, 30% on business credit-card accounts, and 25% on commercial and industrial credits. Heaping insult upon injury, some banks are even dropping out of lending syndicates.

There are no magic solutions as to how to finance projects, acquisitions and equipment in such conditions. But there is a practical step: to opt out of the search. Having cut plant, equipment and inventories, some companies’ capital needs have shrunk dramatically. Indeed, 60% of banks worldwide reported a reduction in demand for commercial and industrial loans during the fourth quarter of 2008, according to the Federal Reserve.

But if they don’t want to sit out the downturn, CFOs in the US trying to corral capital can turn to European or Asian banks or smaller, regional 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 US, as are banks from Singapore and South Korea. “These are potential pools of liquidity that US 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 non-US 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 a 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. It’s time to uncover opportunities elsewhere.” Davidson cites several regional banks, including Wells Fargo, Comerica and US Bancorp, as less affected by the subprime crisis and “still having their wits about them.”

Meanwhile in Asia…
Michael Austin, CFO of Top Form International, the world’s largest manufacturer of bras, takes a document from his desk. “This is the first time we’ve received something like this,” he says. It’s an addendum to the annual renewal form for a finance line with an international bank. “Here is some information they now require.” He takes a breath. “Sales figures, updated management accounts, age analysis of trade debtors, orders on hand for the current year, average monthly wages, a list of our raw-materials suppliers, days of credit period for our largest suppliers. They also want to know who our other bankers are and what pricing they’re offering.” He laughs at that last item, but he would be the first to agree that the banking situation in Asia is anything but funny. From Hong Kong, where Top Form is based, to Australia, Japan and China, banks are tightening their lending practices.

“Financing has become very hard here,” says Arvind Chandak, president of Aurobindo Pharma’s China operations. The $700m Indian-owned drugmaker has a $100m investment in a new plant in Datong, in China’s Shanxi province, and wants to increase capacity. But it is having trouble securing the 200m yuan (€23m) of financing the project requires, not to mention the working-capital lines it needs for its current plant. A combination of factors stand in the way, including local bank reluctance to lend to exporters, the difficulty of importing a large sum of foreign currency to convert into yuan (China has strict capital controls), and local rules in Datong that make it difficult for a corporate borrower to raise more than 100m yuan from a local bank.

Aurobindo is not alone. At the Philippines operation of a European-owned garment exporter, the controller reports that the company can no longer get working-capital loans from the local banks it has long relied on. The banks keep asking for more documentation from the company but don’t extend credit. “It’s as if the bank doesn’t want to release the loans,” he says. To get by, the company is slowing down payments to its own suppliers. It has also secured some short-term loans from what the controller will only describe as “private individuals.”

“The discussions in credit committees are getting tougher,” says Matthew Austen, a partner at Oliver Wyman’s corporate and institutional banking practice. “Covenants might well get tougher. Banks are looking at ways they can alter the terms and conditions and covenants to wrap the loans in protective padding.”

Robert DeLuca, executive general manager of corporate financial services for Commonwealth Bank, one of Australia’s big four banks, puts it plainly. “The availability and the cost of capital have changed a hell of a lot over the past six months,” he says. “It started last year at the high end and has now moved into the mid-market as well. There are a number of different factors. Obviously for our bank and other financial institutions, there’s the ability to raise capital and what it’s costing us to raise it in the wholesale market. We’ve also started to increase the risk margin. Terms and conditions have become a lot tighter. Previously, banks were prepared to give out credit on much looser terms. Now we’re looking for more security, less gearing and more guarantees from owners and directors of the company. We are also less prepared to back businesses that don’t have a strong history of profit or cash flow.”

While Asian banks, like their US and European counterparts, are pulling back in response to the higher risk of defaults, most remain comparatively healthy. Indeed, a bright spot, experts say, is that the retrenchment on the part of large banks has given smaller regional players a chance to step in. Austen says that local banks see an opportunity to capture some market share. But, he adds, there’s a danger that these banks will “dive in and catch all the credit losses expected in the next couple of years.”

From a corporate perspective, any involvement is seen as positive. When Straits Asia, a Singapore-listed coal-mining company that was spun off from Australia’s Straits Resources in 2006, sought refinancing on a $300m loan in late November, it got a hard lesson in just how bad things had got.

The company had to pay 325 basis points over Libor. And to convince its lender, Standard Chartered, to take the full loan onto its balance sheet, it issued 35m warrants to the bank. The warrants (which have a strike price of 20% over Straits Asia’s stock price at the time of the loan) mature when the loan is due in May 2010.

It was hardly the deal that CFO Jim Carter hoped for, and just three months before it was struck he faced a far rosier outlook. Seeking, at that time, a five-year, $400m loan to replace a $200m bridge loan, Carter found that the members of the ten-bank syndicate that provided the original loan were most receptive. “There were some core banks we had been building relationships with,” says Carter. “They knew us and understood mining. A five-year loan for $400m sounded achievable.”

Then came the September meltdown. “We were trying to refinance in the middle of the worst markets most of us have ever experienced,” he recalls. “Our banks were in pretty good shape, but there was a whole change in sentiment. It got worse and worse. By the last week of September, any company that had funding coming up in the next three months was getting hammered in the market. People were saying ‘You’re not going to be able to refinance.’”

“Credit committees had completely changed,” adds Carter. “The level of questioning and due diligence bacame a lot more detailed. People were saying that the syndicated market was closed for the year. We needed a needed a plan B.” That plan B came when one-and only one-of Straits Asia’s core banks came forward with the offer to do a bilateral loan for a smaller amount and shorter term than Carter had wanted.

The CFO had to address one potential wrinkle: issuing the warrants would dilute existing shareholders by 3%. Carter sounded out the company’s major shareholders on how they felt about the refinancing if it meant dilution? “The response was overwhelming,” he says. “They said, ‘If you can secure financing, do it. You can live to refinance in better times.’”

“We realised that it wasn’t the time to be trying to screw the banks for the last basis point,” Carter continues. “The equity markets are closed. The debt markets have been closed for a long time. There just aren’t any other options.”

Additional reporting by Russ Banham and Don Durfee.

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