Does anyone out there need a loan?

We stumbled upon these striking charts in an article in the Financial Times recently. It has interesting implications for credit analysis. The last decade’s boom in credit has been remarkable, led, of course, by mortgage-backed securities. But debt funding by companies is a close second, if you count “corporates” and “money-markets.” There are plenty of reasons to believe the surge in corporate debt will continue. Equity’s miserable performance over the last ten years makes it much more expensive than debt, for one thing. And businesses in developing economies are hungry for capital, for another. Although the article focuses on trading opportunities, debt markets move on a couple of drivers: technicals like changing interest rates and fundamentals like credit quality. After the market seizures of 2008, portfolio managers  can’t be so confident they can trade their way out of a poor credit position. That means strong demand for credit analysis at origination and in the after-market. Corporate loan and bond portfolios did not take the same drubbing as the mortgage-backed markets over the last several years, but doesn’t mean they were risk-free. At the worst, the global default rate on investment-grade bonds was 5.4% in 2009, and on non-investment grade bonds it was 13.0%.  Commercial loan delinquencies in the United States were at a 4.5% rate at the end of 2009. The debt markets got a memorable course of risk-aversion therapy recently, and they’re likely to remain acutely risk-conscious for some time. Regulators doubtless will be especially vigilant about credit risk as well. Banks, investors, and traders who take credit risk will want to pay close attention to the fundamentals....

Bridge Loans Make Large Acquisitions Possible

For many companies, financing an acquisition is a two-step process.  The long-term strategy might call for raising cash using syndicated term loans and revolvers, bonds, equity, and asset sales. However, many companies use bridge loans to initially fund acquisitions, then repay those loans with other financings and/or assets sales.  In fact, according to Reuters, the largest syndicated loan in the U.S. in 2008 was the $14.5 billion one-year bridge loan backing Verizon Wireless’ acquisition of Alltel Corp.   What is a Bridge Loan? A bridge loan is a term loan where the expected source of repayment is a specific event, typically a debt or equity financing and/or asset sale.  These loans typically have a bullet maturity (i.e. no amortization) of 1 year or less.  As an incentive to borrowers to refinance bridge loans quickly, they typically include interest rate increases and “duration fees” tied to how long the loan is outstanding.  For example, the Altria bridge loan (described below) calls for the interest rate to increase by 0.25% and for an additional 0.75% fee if the loan is not repaid within 90 days (with additional step-ups and fees each 90 days thereafter).  Bridge loans are typically underwritten by a small group of banks rather than being widely distributed in the syndicated loan market.  These underwriting banks typically also manage the “takeout financing” (e.g. the bonds issued to repay the bridge loan).   Altria Uses a Bridge Loan On September 8, 2008, Altria Group, Inc., the parent company for cigarette maker Philip Morris USA and other companies, announced an agreement to purchase UST Inc., a leading manufacturer of smokeless tobacco. ...

Inventories Explode

Over the past 15 year, many businesses have adopted sophisticated inventory tracking systems and just-in-time inventory policies.  As a result, they have gotten much more efficient in their use of inventory, as shown in this chart: Source: Wachovia Economics   This long downward trend in the inventory-to-sales ratio has recently and dramatically reversed.  What happened?   As we noted in an earlier post, companies are often slow to respond to lower sales, waiting to cut production and/or reduce purchases.  As managements “catch up” to the current sales reality (or as sales improve), we would expect the inventory-to-sales ratio to return to normal, lower, levels (with the associated benefits for corporate cash...

More on General Motor’s Predicament

How did General Motor’s run through so much liquidity so fast? Static measures like cash and liquidity don’t really give us the full answer. We need a more dynamic view of what’s driving GM’s liquidity; something that focuses on uses and sources instead.   Here’s a table that shows where GM has been using and sourcing its liquidity for the nine months ending in September of this year.   Cash income has been the biggest use of liquidity, caused by the steep drop in vehicle sales that began earlier this year. Working capital has been a use largely because of decreasing accounts payable – a sign that suppliers are cutting back on the credit they give GM. Capital spending is another major use, as the company invests in new models. Credit market conditions forced GM to pay down much of its short-term debt, draining away even more liquidity.   GM met those demands for liquidity through liquidating assets, mainly by selling marketable securities and letting its portfolio of vehicle leases run off. The next biggest source was borrowing under its committed bank lines. But the most important source of liquidity by far was drawing on cash reserves.   GM found the sources it needed to survive, but only by consuming crucial liquidity reserves. That’s not sustainable. As of September 30, 2008, the company had only $7.2 billion in operating lease assets, $300 million in marketable securities, $16.0 billion in cash and equivalents, and $100 million in unused bank lines – at best enough last another nine months.   So it seems GM has been telling the truth. It really...