Commercial lines of credit are in the crosshairs of banks as they seek to reduce liquidity risk and keep their loan portfolios from ballooning. Banks are downsizing companies’ revolving lines of credit and exercising their “participation rights”—the option to pull out of loan syndications.
Data from bank call reports filed with the Federal Reserve show that banks with large losses in residential mortgage lending and the related securities markets are cutting their idle commercial lines of credit. At Wachovia Corp., unused commercial credit commitments to U.S. companies dipped 10 percent in the second quarter compared with one year ago, to $151 billion. Merrill Lynch’s commercial bank reported that unused lines dropped by 25 percent to, $31.3 billion, in comparison with last year. Similar trends have occurred at National City, Lehman Brothers Commercial Bank, and others.
New issuance of commercial revolvers has also fallen off a cliff. In the first half of 2008, $288.2 billion of lines were originated, almost 50 percent less than were issued in the first half of 2007, according to data from Reuters Loan Pricing Corp.
Especially at risk of losing their revolving credit lines or having them reduced: companies that tap a fraction of their lines of credit at any given time. That’s a large population: more than 40 percent of finance chiefs responding to an August CFO survey on banking said their companies currently had no outstanding balance on their line of credit.
“It’s the worst credit environment I’ve seen, and I’ve been with the company 18 years,” says Bob Quint, CFO of the Radian Group, a $1.3 billion bond insurer. Last April, ahead of a credit downgrade, Radian renegotiated the ratings covenant out of its revolving credit facility. The lender wound up cutting the commitment size by 37 percent, to $250 million, and secured it with Radian assets.
Banks simply don’t make money on credit lines, and may even lose money if the credit lines are a substitute for more productive loans. Returns increase only when amounts are drawn, when banks also issue a term loan, or when opening a line leads to sales of other profitable services to the customer, like cash management. As a remedy, banks have tried to raise fees for unused credit lines above a typical 25 basis points, but fierce competition has often stymied those efforts.
Lines of credit “are attractive to us in the context of a broader relationship,” says Todd Morgano, a spokesman for National City, a regional retail bank. “We are moving forward with less emphasis being placed on standalone credit.”
Even capital-constrained banks cannot simply yank lines of credit to large corporations without repercussions, says consultant John Walenta, a partner in the corporate and institutional banking practice at Oliver Wyman. But they can seek modifications—like downsizing the line—especially if a company is close to violating a covenant. Middle-market companies and small businesses may be the most at risk for such modifications when it comes to revolving credit lines. With those customers, a line of credit more often is simply a “demand note”—the bank has the contractual right to demand full repayment and pull it at any time.
The terms and conditions banks are requiring for lines of credit now are just not what CFOs have been used to in the last few years, says Bob Graves, co-chair of the banking and finance practice at Jones Day. “They are much tighter, more onerous, and more expensive,” Graves says. “The CFO has to swallow hard and say, ‘What’s this worth to me?’”
(For more in-depth coverage of credit lines, see the upcoming October issue of CFO.)