So far the committee has not directly addressed liquidity risk stemming from undrawn commercial lines of credit. Agreement exists, however, that they represent a significant threat to liquidity in the banking system. A recent CFO survey found that 43 percent of U.S. companies and 59 percent of European companies have not drawn down any portion of their lines.
“How does a banking organization come up with the liquidity if there is suddenly a massive run to the bank to draw on those lines?” asks Bert Ely, an independent banking consultant. “We need to factor this more explicitly into the capital requirements of banks — that feeds back into pricing.” That could boost the cost of credit lines, Ely says. The good news for companies? “The Basel process is slow and cumbersome.”
Banks alleviate pressure on their balance sheets by selling loans to other investors, but offloading lines of credit defeats the goal of eventually booking profitable loans. If banks want to adjust the business model by initiating lines of credit and then handing them to other lenders (somewhat like origination fees for home mortgages) that’s another matter, but fees would likely be razor-thin. Moreover, if activity in the market for investment-grade loans (which plummeted 66 percent in the first half of 2008, according to Reuters Loan Pricing Corp.) is any indication, there would be few if any buyers.
A sliver of good news awaits credit-hungry CFOs. By historic standards, loans are very cheap, says Four Corners’s McAdams, whose firm structures fixed-income investments. That could entice buyers. And if inflation goes on a rampage, it could draw investors seeking a buffer against interest-rate hikes, because loans are floating-rate products. “They can pick up spread” without going further out on the yield curve, he explains.
Enduring the Irony
But good returns for investors mean the loan market is pricey for issuers. Double-B credits were paying spreads of 300 to 400 basis points in late summer, on top of original issue discounts — pricing below par that increases the return. Hudson Products, a B-credit manufacturer of air coolers and fans, had to sweeten its loan deal twice in August, eventually offering a discounted yield of LIBOR plus 623 basis points.
To maintain fluid credit lines, CFOs should strengthen their relationships with well-capitalized banks while keeping an eye on banks’ balance sheets. Credit ratings alone tell an incomplete story: watch the same dashboard that regulators and counterparties use to gauge a bank’s creditworthiness. Robust metrics, say experts, include loan-to-deposit and loan-to-funding ratios as well as a bank’s allowance for loan losses — measured against total loans and against nonperforming assets.
While there is certainly some irony in having to gauge the credit of a lender from which you want credit, BMO Capital Markets’s Casper says it is simply a sign of these troubled times. As one CFO he knows put it, “I now realize I’m a better credit risk than the guys lending money to me.”
Cash counts for a lot today, but tomorrow’s bottom line depends on credit. “You may have strategies, but what about credit?” the treasurer of a West Coast shipping company asks. “In planning, credit now becomes the dominant piece.”
Vincent Ryan is a senior editor at CFO.