VideoIs it an insignificant crack, or a sign that the foundation is about to crumble? That's what Pepco Holdings found itself wondering when one of the 16 participants in its revolving-loan syndicate recently exercised an option to reduce its exposure by 20 percent.
Any threat to its credit line triggers alarm at Pepco. The $1.5 billion revolver provides liquidity for the electric utility's unregulated businesses, which have commodity price exposures and mark-to-market collateral activity, says CFO Paul Barry.
"We had heard of several banks dropping out of credit facilities altogether, so we are fortunate. But the surprise is that only one bank has come to us asking to [offset] some of its exposure," says Barry. "A number of banks are under pressure to do it."
While investment-grade Pepco has largely evaded fallout from the subprime crunch, CFOs at other companies may see lines of credit shrink or even vanish as more banks scramble to buttress teetering capital structures. In response, Pepco has heightened its credit monitoring of financial institutions. "We want to know our exposure to them as a trading partner, especially with volatile commodity prices," Barry says. "We have limited or stopped trading with those that pose a significant risk."
Changes that only marginally disrupt solid borrowers such as Pepco may be more keenly felt in transportation, retail, financial, and other distressed sectors, where routine refinancing arrangements are history. United Airlines, RadioShack, and Radian Group, for example, have gone to unusual lengths in recent months to tailor revolvers or find substitute lenders willing to extend credit lines.
"It's the worst credit environment I've seen, and I've been with the company 18 years," says Bob Quint, CFO of Radian, a $1.3 billion bond insurer. Last April, ahead of a credit downgrade, Radian renegotiated the ratings covenant out of its revolving facility. A less than accommodating bank group cut the commitment size by 37 percent, to $250 million, secured it with Radian assets, and slightly shortened the term. The group also charged an amendment fee of $1.9 million. "For now, we will live with the reduced size of the facility," Quint says. Radian shifted some funds from its financial-guaranty business to its mortgage-insurance business to cover a shortfall.
In this dicey climate, CFOs face tough questions about revolving credit lines. Are they safe? When the time comes to renegotiate, will borrowers have enough clout to secure a newline on similar terms? The answers pose serious implications for day-to-day operations and long-term growth.
Bad Feelings
At banks with huge mortgage losses and write-offs, idle commercial lines of credit are shrinking — but not because companies are borrowing more. According to the Federal Reserve, Wachovia Corp.'s unused commercial-credit commitments to U.S. companies dipped to $151 billion in the second quarter, 10 percent less than a year earlier. Merrill Lynch's commercial bank reports that unused lines dropped by 25 percent, to $31.3 billion, while Cleveland-based National City reports a modest 7 percent pullback in corporate lines of credit, to $20.5 billion.
Data from Reuters Loan Pricing Corp. shows that revolver issuance to companies was tepid in the first half of 2008 — just $288.2 billion, almost 50 percent less than in the first half of 2007. "If banks are feeling bad about life, they start chopping unused lines wherever they can," warns Christopher Whalen, managing director of Institutional Risk Analytics, a firm that monitors bank safety and soundness.
Tremors can be felt far beyond commercial banks. Other financing sources, including institutional investors, show scarce interest in standing behind corporate lines of credit. For borrowers, says David Casper, executive managing director of BMO Capital Markets, "the world has gotten a lot smaller in the last six months."
As pivotal cogs in the corporate credit growth engine, institutional investors have no need to back revolvers with low fees on large commitments. "Investors don't want in-and-out activity," says Steven Bavaria, a managing director in leveraged finance at rating agency DBRS. "They want to get their interest coupon every three months and have the money outstanding earning a return." Even in good times, says Mike McAdams of Los Angeles–based Four Corners Capital Management, many investors participated in revolvers only to stay on line for term loans.
Before financial institutions can even extend credit lines to corporate customers, they must tend to their debt. Together with seven of their money-center peers, Bank of America, Citigroup, and JPMorgan Chase must refinance $247 billion of bonds maturing between October and March 2009, according to Dealogic. Worse, as of September, nearly one in five banks stood on the verge of credit downgrades by Standard & Poor's, up from 9 percent in similar straits a year ago.
Rising demand and weaker credit spell one sure outcome: more-expensive debt for lenders and borrowers. Bankers' borrowing spreads have already doubled since early January, to 377 points over LIBOR and 105 points more than the tab for investment-grade nonfinancials.
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