Small and medium-sized companies are feeling the subprime pinch as many banks are no longer willing and able to lend to them
Every two years, Trumpf, a machine tool manufacturer based in Swabia in southwest Germany, invites its clients to its in-house Intech trade fair. The company uses the platform to showcase its high-tech product range, which includes machines, lasers, software and services.
Last week saw this year's edition of the event. Laser cutters were running full speed in the exhibition hall, while presentations enlightened the trade fair participants about details of production processes and new developments in sheet-metal forming. In just five days, some 1,400 companies from 16 countries visited Trumpf. Most of these are long-term clients, with over half based in Germany.
The mood ought to have been very positive. Economic growth in Germany is stronger than it has been in years and machine manufacturing has recorded its fourth boom year in a row. Companies are operating at full capacity and want to invest.
But a shadow lay over Intech, darkening the mood of organizer and visitors alike: the American subprime mortgage crisis, whose aftershocks have reached as far as provincial southwest Germany.
Many Trumpf clients would love to buy new machines -- if only their bank would play along. Unfortunately that is often no longer the case. Even long-standing clients with spotless balance sheets are suddenly being treated like unreliable loose cannons by their banks, who are acting on the premise that every loan that is not granted is one fewer risk.
"The financial crisis has now lasted so long that it is affecting banks' willingness and ability to give loans to businesses," warned Morgan Stanley analyst Joachim Fels in an Internet forum aimed at small and medium-sized companies.
As early as three weeks ago, Jan Hatzius, chief economist at US investment bank Goldman Sachs, shocked the world with his predictions of a nightmare scenario. With banks involved in the mortgage business standing to lose up to $400 billion, they may be forced to cut lending by up to $2 trillion. "It is easy to see how such a shock could produce a substantial recession...or a long period of very sluggish growth," wrote Hatzius.
And he's not alone in his concerns. "The credit crunch is a danger we must take seriously," says Michael Heise, chief economist at the financial giant Allianz and at Dresdner Bank. And the longer uncertainty surrounds the scope of losses and the longer the liquidity squeeze continues, the greater the crunch will become.
German financial institutions are particularly hard hit by the crunch. They pumped billions into the risky high-interest investment vehicles that US banks used to palm off their skillfully re-packaged junk mortgages -- and helped to contaminate the global financial system in the process.
Now no one really knows how much the problematic investment vehicles are still worth and how many billions are still to be written off. Almost every week, another financial institution discloses new write-downs or has to put billion-dollar risks that were previously concealed off-balance sheet onto their own books. Meanwhile taxpayers are having to dole out ever-vaster sums of money to rescue German commercial bank IKB.
As no one knows any more just how affected their neighbor is, banks no longer trust each other -- and, as a result, are reluctant to lend each other money. Which means that time and again, the European Central Bank (ECB) has had to act to ensure the liquidity of the system -- and practically at any price. Otherwise there is the threat that the banks may run short of cash, particularly over the Christmas period when liquidity is tight.
Last Thursday the situation was clearly particularly serious. Following its regular monthly auction, the ECB pumped €50 billion ($74 billion) of three-month funds into the market. Around 180 banks had put in bids for over €130 billion. The banks were prepared to pay an average rate of 4.7 percent. The difference between that rate and the ECB's key interest rate -- currently at 4 percent -- has never been so large.
Part 2: End of the Credit Boom?
Distrust, expensive liquidity and write-downs make for a miserly mood in bank's lending departments. Which is why HSH Nordbank, the world's largest ship financing institution, has announced that it is turning off the credit tap in the last quarter. "Existing agreements will be processed," CEO Hans Berger explained to the astonished press, "but we will be considerably more restrictive as far as new business is concerned."
For economist Heise, this fits the picture. "The long-lasting credit boom in the eurozone will probably gradually come to an end," he says, explaining that borrowing is bound to get more expensive as a consequence of the subprime crisis. "The tough competition among banks meant that risk was priced too low. That's now being corrected." This was confirmed in October in a poll carried out by Germany's Bundesbank among businesses.
The crane manufacturer Kühnezug, from Schuby in the northern German state of Schleswig-Holstein, saw this sea change coming. The small firm, which has around 50 employees and an annual turnover of €12 million, counts major companies like Siemens and Thyssen-Krupp among its customers. Senior director Manfred Böttcher anticipated the coming downturn last year when, during a business trip to the US, he saw "For Sale" signs in front of many houses. He thought, however, that the problem would be confined to America. "No one had expected the German banks to be so closely tied up in this gamble," says Böttcher.
But now he knows better. Since the crisis erupted, he has been receiving weekly letters and telephone calls from his bank, Deutsche Bank, which has had to write off €2.2 billion as a result of its involvement in the US mortgage market. The bank recently started demanding a meticulous weekly summary of his accounts, and has now started advising him to pay off his credit line, which runs until 2010, sooner if possible. And he shouldn't even think about asking for further credit -- despite his company's full order books for 2008.
Even major players in their sector, such as the Friedrichshafen-based automotive supplier ZF, are feeling the shift. It's true that the firm, which has around 60,000 employees worldwide and a turnover of €13 billion, does not itself depend on credit: the company has net liquidity of around €1 billion. But now ZF is being forced to use this money to come to the aid of more and more of its suppliers. "Nowadays they often have problems obtaining money from banks, particularly if they have a poor rating," says ZF's Chief Financial Officer Willi Berchtold. To prevent suppliers from letting them down, ZF is increasingly often finding itself forced to lend money to its business partners so they can finance their production.
However, tighter credit restrictions only have a limited effect on industry, as companies' financial plans and credit agreements are often fixed years in advance. But the crisis could have a much more dramatic effect on the service sector and on the retail trade, which generally need short-term loans. A fashion boutique, for example, might borrow money to pay for its spring collection. These kinds of loans are normally paid back within three to 10 months. Nevertheless, they account for almost 40 percent of all types of financing.
"Since the start of the financial crisis, short-term loans have become on average up to 1 percent more expensive," says Reinhard Dörfler, managing director of the Chamber of Industry and Commerce for Munich and Upper Bavaria. "That naturally squeezes retailers' profit margins."
As a result, the Munich-based department store chain Ludwig Beck AG carried out a new share issue last week, in order to raise more capital and make itself less dependent on increasingly expensive credit. "Six months ago, long-term credit was still more expensive than credit borrowed in the shorter term," says Ludwig Beck Financial Director Dieter Münch. "Now it's the other way round." On average, the company has to pay 4.7 percent interest, almost one percentage point more than six months ago.
In the Ottensen district of Hamburg, Gerd-Uwe Baden is watching the current situation closely. Baden is the boss of the German subsidiary of the world's largest credit insurer, Euler Hermes, and knows the financing concerns of local firms better than most. As well as the tighter credit conditions, Baden says that there has been, in particular, "a noticeable decline in any form of company financing that would have been passed on to the securities market."
Hardest hit are small and medium-sized companies that are growing quickly but have a thin financial cushion. Mezzanine capital is the name given to injections of money which are a hybrid of loans and equity. Companies must pay hefty interest rates and give shares of their profits to investors in return for the opportunity to boost their balance sheets. For their part, banks bundle together mezzanine loans which they have made to several dozen companies, assign the securitized assets to different risk categories and finally sell on the securities to other banks, the super-rich, insurers and hedge funds.
But now the mezzanine crunch is in full swing. The ongoing financial crisis means it is almost impossible to place new, nicely packaged company loans -- and the old bundles, which have a total volume of some €5 billion, are rapidly turning out to be time bombs.
In a similar fashion to the American mortgage lenders, the big names in German banking supplied sometimes shaky borrowers with extra funds without thoroughly checking the risks involved.
"They did not carry out strict credit screening in these programs," says business consultant Uwe Fleischhauer. "They only looked at past figures, using very rudimentary -- and therefore inexpensive -- analysis methods."
Now the default rate is mounting and the value of the securities is sinking. Market leader Preps, part of the Swiss Capital Efficiency Group, amassed by itself over €2 billion in securities, with the help of HypoVereinsbank among others. Prep is now facing bleak times: Some of the securities have lost up to 50 percent of their value.
Six companies with a total worth of €80 million have already declared bankruptcy. These junk firms include well-known names like the shoe manufacturer Rohde and the football mascot manufacturer Nici. A mezzanine capital financing scheme from Deutsche Bank and IKB had also sunk millions into the latter firm.
"The risk of default is definitely too high," acknowledges Preps founder Sami Chakroun, giving the excuse that there were "criminal acts" on the part of the companies affected. Chakroun thinks that "all the programs have seen defaults." But nobody knows exactly how many, because the market, he says, "is totally untransparent."
The fact of the matter is that Nici's soccer world cup mascot Goleo did not bring investors from the Commerzbank program much luck. And when Schieder, Europe's largest furniture manufacturer, went bankrupt, it cost DZ Bank's special fund a hefty €50 million.
It is still unclear which banks are facing the greatest fall-out from the mezzanine time bomb. Some of them are putting the highest-risk securities onto their own books. Instead of high double-digit yields, losses are now on the horizon. And the mood in banks' commercial lending departments can only get worse.