Now What?

As banks tend to their balance sheets and seek higher returns on capital, corporate lines of credit are becoming more expensive — and tougher to keep.

Wary borrowers now fear lenders won’t be able to renew facilities when they mature. In August, RadioShack issued $325 million in convertible unsecured notes to replace a revolver terminating in June 2009, which it uses for working capital. While RadioShack will pay a lower rate of interest (2.5 percent), it can’t redeem the notes prior to maturity, and the holders can force the company to buy the notes back on a material adverse change. What’s more, $40 million of the proceeds go to hedge against dilution to the company’s common stock when the notes convert to shares.

Middle-market companies and small businesses have less leverage when it comes to protecting their credit lifelines. With these customers, a line of credit more often is simply a demand note. “Absent lenders liability, a bank always had the contractual right to reduce or eliminate a line of credit as it saw fit,” says Robert J. Pruger, finance chief at Rudolph/Libbe Cos., a commercial builder with a $27 million revolver.

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. “We are moving forward with less emphasis being placed on stand-alone credit.”

With bad news surrounding banks, regulators are digging into commercial lending on several levels. They want to know more about the nature of those loans and underlying assets to “detect weaknesses in asset quality that may result from slowing economic conditions and to ensure appropriate risk-management practices,” Donald Kohn, a Fed vice chairman, said during a Senate hearing in June. Regulators are particularly interested in the condition of large syndicated credits shared by three or more banks, as well as underwriting practices for leveraged loans, Kohn said.

That can affect credit lines, says attorney Tom Vartanian, a partner at Fried, Frank, Harris, Shriver & Jacobson LLP and a former general counsel for the Federal Home Loan Bank Board. More scrutiny puts a damper on lending and, by extension, credit. “When a financial institution is hunkering down and regulators are evaluating its risk, capital, and management,” says Vartanian, “it fundamentally means there are fewer funds available at the margins.”

Accounting-rule changes could lower an even weightier boom, not least by forcing wider recognition of credit lines on lenders’ balance sheets. Imminent changes to the Basel II accord, which set standards for how much regulatory capital banks set aside, could off set an expected reduction in capital needed to support commercial loans. The Basel II committee has recommended that by January 2010, banks treat trading and banking portfolios alike, so that both encompass risks related to defaults, liquidity, credit and equity spreads, and changes in credit ratings.


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