And The Crunch Goes On

Call it the case of the chronic credit crunch.

Early in the recession, bad-loan-blighted banks were scared into lending warily. Now that the recession is ending, another type of big-league lender has joined them: insurers. They're spooked by several collapses, most recently that of Mutual Benefit Life Insurance Co.

This is bad news for smaller companies and highly leveraged outfits, which will remain personae non gratae to lenders. But big public companies will benefit from investors' flight to quality, even though one manifestation will be heavy purchases of U. S. Treasury securities. For big companies, the recession's end will make capital even easier to come by. There will be "a good availability of funds for investment-grade markets. But things will be tight for everyone else," says David W. Mullins Jr., vice-chairman at the Federal Reserve. Adds Frank V. Cahouet, chairman of Mellon Bank Corp.: "A whole segment of companies won't get financing and will atrophy. You'll have to wait four years for this to loosen up."

Just ask U. S. Home Corp., a Houston homebuilder whose erratic fortunes after the early-'80s oil bust made lenders leery. This year, U. S. Home needed more money from its 17 bank lenders to complete several partially built projects, put their houses on the market, and generate some much-needed revenue. No dice. Lenders "were nervous about real estate," says spokeswoman Kelly Somoza. Result: The company last April tumbled into Chapter 11 bankruptcy.

BIG HANGOVER. Worse yet, smaller businesses are being cut out of the credit flow. They are a key source of innovation, and, by some calculations, create more than half of all new jobs. Yet borrowing by small businesses has weakened more sharply than in previous recessions. Their outstanding debt has declined during the past two quarters--the first time that has happened in the 40 years such data have been tracked, according to Kidder, Peabody & Co. In many cases, says economist David L. Birch, president of consultant Cognetics Inc., "the bank will just call uptakes action by lowering interest rates. True, the sluggish money supply mostly reflects money moving out of the banking system, while other indicators of real economic activity, such as housing, still point to recovery. Nonetheless, "it's something we're watching closely," says Fed Governor Edward W. Kelley.

What's holding back banks, insurers, and other lenders is the hangover from ill-considered past investments, especially in commercial real estate. The office vacancy rate in 1991's first quarter was 19.5% in cities and 22% in the suburbs, according to Salomon Brothers Inc. Think about it: That's the equivalent of one in five office buildings standing empty. Mutual Benefit's demise was sealed by its heavy mortgage defaults--nearly 10% at the end of 1990.

Once burned, twice shy. So banks and insurers are avoiding other areas they see as too risky. Aetna Life & Casualty Co. is steering clear of junk bonds and is extremely picky about private placements that are often sustenance for medium-size companies (charts).

SECOND TIER. Of course, the Exxons, IBMs, and Philip Morrises of this world rarely have had trouble collaring capital. Below this pantheon, the new golden credit is almost any publicly traded company with a strong balance sheet or good business prospects. Even highly leveraged companies are welcome if their business is sound enough: Duracell, Safeway Stores, and Caldor had no problem floating recent stock offerings. Edward E. Yardeni, chief economist at C. J. Lawrence Inc., says that unlike the 1980s, when the stock market often concentrated on financing buyouts, it now is an arena for raising capital to grow.

Lenders are willing to take another pass at companies able to demonstrate equity investors' confidence, although doing so can be hard work. Energy Ventures Inc., a small oil-field service company in Houston, approached a group of insurers for a private placement loan of about $40 million. The insurers were squeamish, even though the company can easily cover its current debt of $37 million. But after a strong 1990, Energy Venture's earnings had slumped a bit. So the company raised money first by a $17.5 million stock offering on July 10. Now, it has a sporting chance of tapping the insurers, says P. Blake Dupuis, the company's chief financial officer.

Stock offerings have been selling at full tilt. Initial public offerings are up 35% over the comparable stretch last year--injecting billions into fledgling companies. The IPO boom, though, hasn't helped in such out-of-favor areas as chemicals, steel, and publishing.

Other financial trends are good news to top U. S. corporations. Commercial bank lending may be down, but the gap has been partly filled by other lenders, such as the commercial paper market. Also helping the big boys are lower short-term interest rates. Since about 50% of all corporate debt is short-term, the corporate interest bill will drop over the next year. Indeed, interest rates declined even after the Treasury announced on July 31 that it will borrow some $190 billion over the next five months. Rates dropped because the size of the planned borrowings was no surprise. Blue-chip borrowers should also benefit as investors seeking higher returns flock to bond and stock funds, which prefer big-company investments.

ROUGH JUSTICE? This could be the start of a trend. Equities have long been a declining share of household financial assets--dropping from 35% in the late 1960s to less than 20% currently. "But there will be a significant restructuring of individual investor portfolios away from residential real estate and other real assets and into financial assets in the 1990s," says Steven G. Einhorn, a partner at Goldman, Sachs & Co.

Foreign capital is another source of strength for big corporations. In 1990, foreign investors acquired a net $5.9 billion in American corporate bonds and slashed stock holdings by $16 billion. But annualizing 1991's first quarter shows them buying $24.3 billion in bonds and $10.9 billion in stock.

In Darwinian terms, continued tight credit for the less creditworthy may mete out a certain rough justice for the last decade's highfliers. But some deserving little companies or larger highly leveraged enterprises, trying to ride out a sluggish economy, figure to get starved in the process. And that could well deprive business of a good share of the innovation and competition that keeps the economy vibrant.

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