Pedaling As Fast As They Can

Why companies will need to work harder for credit.

FADE 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.


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