Feeling a Credit Squeeze
Banks are tightening up--and they'll only get tougher. That could turn the soft landing into a thud
A year ago, companies were practically fighting off the lenders waving cash at them. But all that has changed since the spring. First, the initial public offering market dried up, making it hard for companies to raise cash by issuing equities. Then the junk-bond market took a hit. Now, banks are cutting back on syndicated lending--big loans that are parceled into chunks and sold off to other banks and investors such as insurance companies. Just $23 billion of these loans were made in the first three weeks of November, vs. $62 billion in the same period in 1998.
No end is in sight to what's starting to look like a slow-motion credit crunch. More than 40% of domestic banks have tightened standards on loans to large and middle-market businesses in the past three months, vs. 25% in May, according to the Federal Reserve's survey of senior bank loan officers, released on Nov. 17. Consequently, bank loans outstanding to commercial and industrial companies not only stopped growing but actually fell 1% in the same period (chart). "This represents a sharp squeeze on corporations, and it happened much faster than we expected," says Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd., a Valhalla (N.Y.) consultancy.PROBLEM LOANS. The squeeze is likely to get even tighter. Over half the domestic banks surveyed expect to tighten their standards in the next year, according to the Fed. Worries about problem loans are at the heart of the matter--they've doubled since 1998. "Credit quality is deteriorating quarter by quarter," Bank One Corp. CEO James Dimon told the Economic Club of Chicago on Nov. 15.
If the trend continues to accelerate, it could ultimately force a far harder landing than Fed Chairman Alan Greenspan hopes to orchestrate. Real growth is expected to slow to 3% next year, from an estimated 5.2% this year. But if business confidence takes a severe knock, the slowdown could become more brutal. Already, credit tightening is pushing troubled companies to the wall. On Nov. 15, for example, Regal Cinemas said it is considering filing for bankruptcy because it is violating terms of its loans and is not sure it will be able to renegotiate.
Bankers are unapologetic about tightening their purse strings. To them, it simply makes good business sense. "Markets want to back winners," says Peter Gleysteen, recently named chief credit officer at soon-to-be-merged J.P. Morgan Chase & Co., and former head of global syndications at Chase.
The banks' new muscular approach could come back and bite them. The current crackdown is forcing some companies that can't get new loans to rely on previously arranged lines of credit--the corporate equivalent of living day-to-day on a credit card. The volume of these off-balance-sheet credit lines has nearly doubled since just before the last recession of the early '90s, to about 30% of all bank loans, according to bank analyst Michael L. Mayo.
Such credit lines are usually offered with a loan when times are good. The banks earn fees for the arrangement--from 0.25% to 2% of the loan a year--but don't generally expect companies to use them. But cash-poor businesses are drawing on them to make ends meet. Xerox Inc., for example, got a $7 billion credit line in October, 1997, in a deal led by First Chicago, Chase Manhattan, and J.P. Morgan. The troubled Stamford (Conn.) copier company--which gave earnings warnings in 4 of the past 5 quarters--said in a Nov. 14 SEC filing that it is unable to access the capital markets or get a bank loan. So it has drawn $5.3 billion of the line since October.
Effectively, banks are forced to make involuntary commercial loans when companies draw big amounts in short periods. As a result, the banks have to use precious capital to back the loans or make costly loan-loss provisions if they fear the borrower may have difficulty repaying on time. The fact that Xerox is still drawing down its credit, despite its questionable financial strength, is leading some to wonder whether banks handed out these lines too liberally in the good times. The rules governing when a company can use such lines, so-called covenants, may be too lax, Mayo says. Some bankers agree that standards were eased in the late 1990s. "Certainly, in some segments there was covenant weakening over the years," says David A. Hoyt, head of wholesale banking at Wells Fargo & Co., though he adds the weakening was "sporadic."DISASTER MOVIES. Whether or not bankers were tough-minded enough in the conditions they attached to the credit lines may be open to debate. But why they made them in the first place isn't: The lines were a by-product of the battle to dominate the lucrative syndicated loan market. Chase Manhattan Corp. and Bank of America Corp. have dominated in recent years, and the rivalry between the companies' loan teams is legendary. Handing companies hefty credit lines was a way of getting them to sign up for lucrative loan business.
Companies that arranged credit lines before the summer can count themselves lucky. Already, weaker companies without such lines are getting whacked. "A major reason companies are filing bankruptcy now as opposed to six months ago, when their condition was just as shaky, is that they're going back to their banks for money and the banks are saying no," says Martin S. Fridson, Merrill Lynch Global Securities chief high-yield strategist.
Movie theater chains, for example, are reeling because the business is suffering from severe overcapacity, much of it financed by hefty leverage. On Aug. 1, Carmike Cinemas Inc., one of the nation's largest chains, said that its lead banker, Wachovia Corp., would not allow it to make interest payments to its senior bondholders, since Carmike had violated some of the provisions in its loan agreement with Wachovia. A week later, it filed for Chapter 11 bankruptcy. Then, on Sept. 5, United Artists Pictures Inc. filed for Chapter 11.
Companies that want to delay payments or restructure loans are finding their bankers less sympathetic, too. Take AMF Bowling Inc., the world's largest operator of bowling alleys. Its customers have dwindled, and cash flow has decreased 30% over the past two years. AMF did not make a Sept. 15 interest payment due on its bonds and started working with Citigroup to restructure its debt. Negotiations haven't gone well--on Nov. 14 the company said it was considering filing for bankruptcy.
Bankers are loath to characterize what has been happening as a credit crunch. The rise in credit problems and subsequent credit tightening is coming off years of excellent results, they say. Indeed, some worry that the attention now being given to credit quality, plus the banks' swing to more conservative lending, may choke off liquidity too much. "When we're talking about fundamentally healthy markets, we don't want credit concerns to become disproportional," says Chase's Gleysteen. Judging by banks' actions, though, it may already be too late.By Heather Timmons, with Debra Sparks, in New York, and Bureau ReportsReturn to top