Baby It's Cold Out There Who is getting credit and when will the rest of us feel the warmth?
By David M. Weinstein
Principal, Lakeside Advisors
Reprinted with permission from The Journal of Corporate Renewal,
copyright Turnaround Management Association.
No matter what your politics may be the financial community has to agree that the one thing global warming has not affected are the frozen credit markets.There remains a distinct chill in the credit air as banks continue to hold back extending new credit let alone supporting old credits.Sure some deals are getting done, but they are clearly the exception, not the norm.
Credit is the provision of resources (such as granting a loan) by one party to another party where that second party does not reimburse the first party immediately, thereby generating a debt, and instead arranges either to repay or return those resources (or material(s) of equal value) at a later date. It is any form of deferred payment.The first party is called a creditor, also known as a lender, while the second party is called a debtor, also known as a borrower.Movements of financial capital are normally dependent on either credit or equity transfers.Credit is in turn dependent on the reputation or creditworthiness of the entity which takes responsibility for the funds. (Source: http://www.ask.com/bar?q=define+credit+market&page=1&qsrc=0&ab=0&u=http%3A%2F%2Fen.wikipedia.org%2Fwiki%2FCredit_%28finance%29) There are several types of credit in the marketplace, of course there are hybrids of these types of credit but for simplicity let’s assume these are standalone vehicles for extending credit:
·Traditional factoring which includes the purchase of accounts receivable, both on a full and non recourse basis, notification and non notification alike; ·Asset based lending (from private finance companies and bank owned finance companies), in which the assets, typically accounts receivable and inventory are lent on a formula basis which creates the Borrowing Base of eligible collateral; ·Traditional bank “cash flow/relationship” lending, were debt service, interest coverage and leverage ratios are the guiding factors; ·Hedge fund transactions including mezzanine and other subordinated debt instruments where longer term debt instruments that may or may not have some conversion rights into equity or simply yield a high rate; and ·The domestic and international credit markets where companies can bridge short term needs with commercial paper or other capital market debt instruments. There is no doubt that the current “credit situation” has garnered its share of headlines.Every financial website, television talk show, press briefing and business magazine decries the lack of credit.And how this lack of credit is impairing the economic recovery.And all the government stimuli, (stimulus by any other name is simply a bailout) which are intended to restore confidence in the financial markets and get “credit flowing again.”Yet sadly, with the hundreds of billions of dollars already approved and in the “system” from the government, not including the trillions from the Federal Reserve which is separate from the governments stimuli, credit isn’t flowing. Keep Rates Low and Banks Will Lend, or Will they?The US (and world) economy is in an unprecedented time with regard to a favorable interest rate environment.Following is sampling of current rates which are the basis for most credit pricing. (Source: http://www.moneycafe.com/markets/interestrates.htm?qm_target_page=Rates. 3/22/09.)
If a bank doesn’t put the new capital to work earning a profit or reducing a loss, its returns for its shareholders will suffer.
Fed Funds at less than one quarter of one percent!The Prime Rate at three and one quarter percent!One month LIBOR at one half percent!A 30 year rate mortgage at under five percent!One would think this is the ideal time to finance an expansion ofyour business, (working capital and physical plant) or refinance your house.These are rate levels unseen for decades!Yet sadly, credit remains unavailable to many businesses and individuals.In fact, there are many banks now imposing “minimum rates” in their loan agreements which completely negates the benefit this low rate environment can provide.For example, a customer who has a “Prime Rate loan” which would be 3.25% in this market is being charged a minimum rate of 5% effectively making the so-called “Prime Rate” loan a Prime plus 1.75%.It begs the question that assuming the banks are funded by Fed Funds at .18% then their spread over cost of funds is 4.82%!Historically, the Prime Rate averaged about 3% over cost of funds, which it still does (3.25% Prime Rate less Fed Funds of .18% = 3.07% spread).So not only are the banks not lending in any great capacity but when they are, they are garnering an extra 1.82% vig. So with rates at historically low levels and government stimulus, bailouts and other unprecedented support at historically high levels, shouldn’t credit, as defined be flowing?With all the worldwide cooperation from the G20 nations to bolster their respective economies and banking systems to support import/export financing, shouldn’t credit be flowing?With government bank ownership (not nationalization but stock ownership) at historically high levels, why isn’t credit flowing? One need only attend a few (credit and equity) industry gatherings, and listen to the chatter amongst those in the trenches, those either providing credit or those looking to borrow it.Bankers bemoan they have liquidity, (TARP money or otherwise) but cant lend due primarily to fear and paralysis as to not knowing what else they don’t know about their portfolios; borrowers gripe they have “funding ready” (the financial equivalent to the new mantra of “shovel ready”) deals but can get credit.Other lenders talk of how they can only fund, sometimes on a limited basis existing customers and “are keeping their powder dry until things change.” Where are the cracks in the ice: ·Traditional factors are lending but they may be under increasing pressure from their warehouse line of credit banks may be pulling back in order to shave the riskiest loans from their portfolios.Those that were funded by hedge funds face pulled lines of credit as the hedge fund themselves are being faced with investor redemption calls. ·Asset based lenders, also funded by banks may have restricted warehouse lines due to their banks reluctance to lend.Those funded by hedge funds face the same plight as the traditional factors. ·
The problem at the heart of commercial banking: how to keep credit quality high while generating greater loan volume.
Regional banks that are those banks focused on a specific geography (or “footprint” as they refer to it) are more inclined to support local borrowers.These are typically smaller banks (not necessarily savings & loans but regional commercial banks) that have not participated in the trading of the so called toxic loans that seem to be the demise of the money center banks and investment banks remain strong even without TARP money.These regional banks have preferred not to take TARP money so that they could “run their business without government oversight” but yet remain in neutral or at best in first gear on new fundings.
·Hedge funds, as we used to know them, are functionally dead.Their funding from investors has dried up and they are facing substantial capital calls.This has caused the fund to draw down on their bank lines to fund these redemptions causing the banks to cut back on the lines of credit that were extended with little expectation they would ever be used. ·Credit markets, not to be confused with the stock market remain stagnant as fear of the “other shoe dropping” paralyzes them. Of course Citibank, Bank of America, Wells Fargo and other large institutions garner the bulk of the headlines based on sheer size and the fun it is to poke sticks at the big dogs; but it’s the regional banks that will provide the catalyst, on a region by region basis to the thawing of the credit freeze.The chart below shows the rise in loan loss reserves since the fourth quarter of 2008 and January, 2009: If the intention of these stimulus packages and TARP (Troubled Asset Relief Program) dollars was to “replace” the losses owing to the subprime mortgages, allowing the institutions to write off the bad “toxic” debt, these new government dollars should have replaced those losses with new money leaving the banks balances intact and ready to lend.So far that hasn’t happened on a terribly large scale but then again, a financial crisis is nothing without a crisis of confidence. As the economy sours, unemployment rises, home prices tumble and loan defaults soar, bank failures have cascaded and sapped billions out of the deposit insurance fund. It now stands at its lowest level in nearly a quarter-century, $18.9 billion as of Dec. 31, compared with $52.4 billion at the end of 2007.The FDIC expects that bank failures will cost the insurance fund around $65 billion through 2013.The agency noted that “the nation's banks and thrifts lost $32.1 billion in the final quarter of last year, even worse than the $26.2 billion originally reported last month.” Rising losses on loans and eroding values of assets bit into the revenue of U.S. banks and thrifts in late 2008, causing them to post the first quarterly (industry) deficit in 18 years. The $26.2 billion loss originally reported for the October-December period already was the largest in 25 years of FDIC records. It compared with a $575 million industry profit in the fourth quarter of 2007.And the originally reported 2008 net income of $16.1 billion was the smallest annual profit since 1990, during the savings and loan crisis. The 20 bank collapses this year follow 25 failures in 2008, which included two of the biggest savings and loans, Washington Mutual and IndyMac Bank.Last year's total was more than in the previous five years combined and up from only three failures in 2007.
The FDIC had 252 banks and thrifts on its list of troubled institutions at the end of 2008, up from 171 in the third quarter.For a complete list of banks that have failed in since 2000, go to: http://www.fdic.gov/bank/individual/failed/banklist.html.The list of 20 banks that the FDIC took over since the beginning of 2009 is impressive enough:
So this list begs the question as to whether the TARP funds, the stimulus round I or the certainty of stimulus round 2 will be enough is problematic.If banks, large and small stay in this semi frozen state, then what will be known as the winter of discontent may drag on for many more months to come.
