Corporate Financing in a Pinch


As banks and other syndicated lenders get cold feet about new deals, borrowers turn to nontraditional sources of capital—and face tougher loan terms

With the credit crunch in full swing, companies big and small are having to scramble to find financing. The usual venues for loans have dried up. Total U.S. syndicated corporate loan issuance—loans banks made with the intent to sell them off to investors—fell by more than 60% year-over-year during the second quarter of 2008, from $581.8 billion to $229.6 billion, according to Reuters (TRI). Major players, including Merrill Lynch (MER) and Deutsche Bank (DB), have all but exited the U.S. syndicated loan market, with their issuance dropping from nearly $30 billion and $50 billion, respectively, to a combined $5.5 billion during the same period.

Banks haven't ceased lending altogether, of course. But they've tightened their standards enough that companies, once flush with opportunities, have fewer options to meet their borrowing needs. The latest Federal Reserve Loan Officer Survey found that more than 80% of domestic banks had increased the spread over their cost, effectively raising rates, and 8 out of 10 said they had tightened lending standards. "Ten banks used to bid [to finance] our projects," says Mark Laport, president and chief executive of hotel developer Concord Hospitality. "Now we grovel and beg."

But all the imploring in the world won't necessarily result in a loan, as AIG (AIG) discovered. Despite the best efforts of Goldman Sachs (GS) and JPMorgan Chase (JPM) to arrange a $70 billion short-term loan for AIG, other financial institutions balked. The U.S. Treasury was then forced to step up as lender of last resort, supplying an $85 billion lifeline. But the loan didn't come cheap: AIG will pay 8.5 percentage points over the London Interbank Offer Rate, which computes to roughly 11%. The insurance behemoth will also give the U.S. government a nearly 80% equity stake in the company. "It's a very risky move, and the terms of the loan reflect that risk," says Stephen J. Czech of SJC Capital Partners.

New Players on the Scene

Most companies, of course, cannot rely on the U.S. government as a backstop. (Just ask Lehman Brothers.) But even as companies find traditional credit sources drying up, new ones are emerging. GE Capital (GE) and BNP Paribas (BNPP.PA), once barely in the top 25 among syndicated lenders, have jumped into the top 10. Meanwhile, the financing arms of companies such as IBM (IBM) and Caterpillar (CAT) have continued to expand. Private equity firms and hedge funds, too, are getting into the game. When HedgeFund.net launched its asset-backed lending index, which tracks hedge funds that use investor capital to make loans, in May 2007, it had just 30 funds; now there are more than 90.

Nonetheless, even the strongest companies are finding that they have to jump through hoops to secure financing. Allegheny Energy (AYE), a Pennsylvania utility, needed $550 million to begin work on an electrical grid project that would help reduce the stress on the Appalachian infrastructure. Working with its regular lender, Citigroup (C), and BNP Paribas, a French bank that specializes in long-term infrastructure projects, Allegheny, structured the loan in a way that appealed to both types of banks—the financial-services behemoth and the project lender. Still, while negotiating a loan normally takes two to three months, the company said, it took twice as long to cobble together a financing deal in this environment. And while the 5% rate on the loan is higher than it would have been before the start of the credit crunch, Allegheny Chief Financial Officer Philip Goulding feels the company "achieved a fair and reasonable rate."

Companies with even a hint of trouble on their balance sheet, whether erratic cash flow or something more serious, must pay special attention to the terms of their borrowing. Most loans contain financial targets that companies must meet to avoid being penalized, called covenants. Before the credit crunch, if a company missed one of its covenants—say, its revenue came in slightly below the agreed-upon level—the company would report the breach to its lender, submit an action plan to fix the problem, and pay a small penalty. Those days, however, are gone. Now, not only will the lender assess a fine, it will also typically raise rates by at least a percentage point and sometimes even force a borrower to sell assets. "Every time there's a breach, it's an event," says Stephen Boyko, an attorney at Proskauer Rose.

Loan Terms Can Be Punishing

Flexibility is one reason Kohlberg & Co. decided to work with GE after its purchase of ice hockey equipment maker Bauer from Nike (NKE) in February. Bauer needed a nearly $120 million loan to set up the company as a stand-alone entity. But hockey is a seasonal business, and GE structured the covenants to take Bauer's fluctuating revenues into account. "Today's environment doesn't usually allow the flexibility you might have obtained one or two years ago," says Kohlberg partner Chris Anderson. "But GE was willing to work with us to achieve the type of flexibility we needed."

Not everyone is so lucky. The wrong loan can lead to a downward spiral of defaults, penalties, and more defaults. That's the situation electricity supplier Commerce Energy Group (EGR) finds itself in. Based in Costa Mesa, Calif., Commerce supplies electricity to homes and businesses. Unlike most utilities, however, it doesn't produce its own energy, but instead buys it on the open market. Commerce got crushed by rapidly rising energy prices. It started piling up quarterly losses, and its share price plummeted. During the past year, Commerce has been forced to renegotiate its loan agreement at least seven times after missing its financial benchmarks.

At first, penalties were small—in November, Commerce paid a $75,000 fee to change the loan terms. But as Commerce continued to struggle, its lenders, Wachovia Capital Finance (WB) and a rotating group of other banks, raised rates—1.5 percentage points from March to June alone. Servicing its debt cost Commerce nearly $8 million, according to the company's most recent earnings statement. By August, Wachovia and the other lenders wanted out, and Commerce pledged to find new financing. To tide it over, Commerce secured a nearly $21 million bridge loan from hedge fund Platinum Partners. That loan, with repayment due in December, requires the company to pay a current interest rate of 12%, as well as a 10% fee at maturity. As with AIG, tough times required tough terms. "We talked to traditional banks, private equity firms, hedge funds. We talked to subordinated and mezzanine lenders," said Commerce CFO Douglas Mitchell. "I think we covered the gamut."


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