Eastman Kodak Co. could have been expected to continue using Bankers Trust Co. as the lead bank on its line of credit when it refinanced the loan this past spring. After all, Bankers had arranged Kodak's old line in 1992. But when Kodak asked for bids on the $2.5 billion refinancing, the response from banks was surprisingly aggressive.
In the end, Kodak chose Bank of America and Chemical to spearhead the financing. Kodak is now paying an annual rate to have the funds available of just 12.5 basis points over the London interbank offered rate (LIBOR) for its credit line, down from 25 basis points over LIBOR on its old line. That's a small change, but on a $2.5 billion loan, it is a savings of nearly $3.1 million a year, according to Cary G. Schmiedel, director of corporate financing. Chemical, Bank of America, and Bankers Trust decline to comment on the specifics of the financing. The fierceness of the bidding for Kodak's business underscores a dramatic change in the market for loans: The banks are back--big time.
FREE TOASTERS? Credit is spewing forth from bank coffers, and spreads on floating-rate bank loans are narrowing. Large banks' corporate lending is presently up more than 6% over last year (chart), and all indications are that the growth will continue. Now, things are getting even looser: The covenants on those loans are easing, and the terms on many loans are lengthening. Banks are eagerly financing acquisitions--a far more volatile business than financing capital investments--and some deals are even getting done on the basis of borrowers' anticipated financial strength, rather than on their actual conditions when the loan is made. Such arrangements were last seen in the heyday of aggressive corporate lending in the late 1980s.
Bankers say their improved numbers and the heavy emphasis on
investment-grade financings are making the loan market today a place of relatively low risk. But for many observers, the current conditions in the corporate loan market are all too familiar--and worrisome. They say that problems are scarce today, and far fewer high-risk deals are getting financed now than in the late 1980s. But the eagerness of the lenders, and the speed at which banks have bid lower rates on new loans, suggest that even easier credit could soon follow, with predictable results. "They're making loans at razor-thin spreads and setting the stage for making loans later on that will not be good," says Edward E. Furash, chairman of consulting firm Furash & Co. "They're stretching again."
There are several reasons for the banks' renewed appetite for lending. To begin with, they have a lot more to lend these days than they did at the beginning of the decade. The fall in short-term interest rates that began in late 1990 enabled banks to buy securities whose prices were rising and whose yields were far higher than the cost of funding the investments, thereby earning record profits. Now, with capital stores replenished, banks are looking for new places to deploy their cash.
The strengthened capital at the banks comes at a time when bonds and other investments are far less alluring. The rise in interest rates during the first half of the year hit hard into the investment portfolios of banks, and continued uncertainty in the market is making the banks wary of further investment. Higher short-term rates are also boosting the cost of financing bond investments. As a result, banks that had been snapping up fixed-income securities are today looking for other investment options.
New rivals add to the competitiveness in the market for corporate loans. CS First Boston and Merrill Lynch & Co. have hired several corporate-lending specialists from money-center banks this year. Superregional banks are also jumping in. Thomas W. Bunn, managing director of NationsBanc Capital Management Corp. in Charlotte, N.C., says his bank was second in number of syndicated deals in 1993.
All this means that bankers are scrambling over each other to do business. They are even pushing to lend to companies whose ratings are below investment grade.
R. Bram Smith, managing director and head of loan syndications, sales, and trading at Bankers Trust, says noninvestment-grade deals are getting done with more leverage and less coverage, and "there's tension to put in less equity." In addition, Smith says, investment-grade companies that were getting three- and five-year financing a couple of years ago can now easily tap the market for seven-year debt and pay almost the same rates and fees.
Banks are increasingly quick to cede protections on loans in a bid to win market share. Companies that used to be required to pledge that 100% of their excess cash flow would be applied to their bank debt are now able to get financing with a 75% requirement or less. Other companies are obtaining financing without material-adverse-change clauses--clauses that allow lenders to shut off credit if a borrower's condition worsens.
As for banks' profit margins on corporate loans, they are shrinking daily. Companies are refinancing loans inside of a year, obtaining lower spreads and longer-term loans. According to Loan Pricing Corp., publisher of a newsletter on the corporate-loan market, Dow Chemical, General Mills, Sprint, and AT&T Capital, among others, have refinanced loans since mid-1993. In many cases, companies are getting new loans with no associated fees. Says one corporate-lending specialist: "We often joke that we're not too far away here from the point where we pay companies to lend them money."
THE BIG SCORE. Acquisition financing is expanding at a particularly rapid rate. Says Thomas H. Hodges, senior vice-president at First Chicago Corp.: "The most active market [for loans] is for clients expanding by acquisition rather than by building new capacity." Thrifty PayLess was a major beneficiary of the eagerness of banks to lend money
for deals. Thrifty, then Thrifty Holdings Inc., wanted a bank loan to help finance its acquisition of PayLess Drugs from Kmart Corp. Thrifty scaled back its original plans to borrow $850 million. Ultimately, though, Thrifty was able to obtain $600 million in bank financing, even though the company, a turnaround with new management, had just begun to generate earnings and positive cash flow after years of losses.
Many of the bank loans getting completed today are refinancings taking place even before loans mature. Burlington Industries Inc. enlisted Chemical Bank in May to help it obtain $905 million in credit that would cut the cost of its bank debt to 62.5 basis points over LIBOR, down from 150 basis points over LIBOR on its August, 1993, borrowing--the company's third refinancing in as many years. The maturities extend as far as 2001, and the company is no longer subject to strict loan-amortization requirements. Says Chief Financial Officer John D. Englar: "I think we are a pretty good barometer of what's happening in the bank-loan market."
Bankers argue that they need to expand their market share in order to get the juicy deals. Despite the minuscule profit margins on most big loans today, the bankers are dreaming of the magic call from a big company looking for a huge, high-margin loan. "The transaction is going to come where you make
a lot of money, so if you maintain a presence, you stand a better chance of getting that deal," says Chad A. Leat, managing director and head of loan syndication at Chase Manhattan Bank. One current high-margin deal: bank financing for Conseco Inc.'s acquisition of Kemper Financial Cos., led by Citibank.
Smaller deals are often profitable, and on the surface, they seem less risky. Little deals, however, don't get the market scrutiny that the big syndicated loans do, so banks can offer outrageously easy terms and lend to highly questionable credit risks in smaller amounts. "The market acts as a very good governor" on large, widely syndicated loans, says James B. Lee, senior managing director in charge of structured finance at Chemical Bank. "The deals I worry about more are much smaller, where the company is smaller and its access to the capital markets is more limited."
No one believes credit-quality problems are anywhere near dangerous levels. For one thing, the economy is on much sounder footing now than it was in the late 1980s, when lending was last this aggressive. And many companies have reduced their own debt burdens, making themselves better credit risks. The banks themselves are also healthier.
Bankers, however, have been confident before, even in the years right before the emerging-market debt crisis and the peak of leveraged buyouts in the booming 1980s--periods when, in hindsight, caution was warranted. Given the bankers' track record, their current confidence could be the first sign of a problem in the making.