New Source of Bank Woes: Companies Drawing Down Credit Lines

The problem with offering deals that involve optionality is that the option will inevitably be exercised only when it is favorable for the user, which as things often work out, can wind up being at a time which is not so hot for the option provider. And in the case of bank standby lines of credit, this is a poor time indeed for them to have more assets loaded onto their balance sheets.

A reader pointed us to this Bloomberg story, “Tribune, Dole May Need to Draw Down Bank Credit Lines,” which suggests that these two companies accessing committed credit lines is a harbinger of further demands on bank equity (note that a standby line does not result in a capital charge until the funds are drawn down).

And the odd bit is that the article mentions rather blandly is that even if Tribune draws downs its full credit lines, it may not be able to pay off its debt maturing in two years. Um, that means if it can’t find a way to refinance it at reasonable terms, it may have to file for bankruptcy

From Bloomberg:

Tribune Co. and Dole Foods Co. may need to draw down on bank lines to avoid default, causing a new drain on bank capital, according to Morgan Stanley analysts.

The companies currently don’t have enough cash and committed credit to cover debt repayments over the next two years and may have to resort to credit lines or “potentially face severe financial difficulty,” said Greg Peters, the head of credit strategy at Morgan Stanley in New York.

For lenders including Citigroup Inc. and Merrill Lynch & Co., prospects that the 80 companies with revolving credit lines of more than $1 billion will start drawing them down threatens to further erode balance sheets that have been hammered by losses from securities linked to U.S. home loans. Banks are restricting lending after $232 billion of credit losses and writedowns from subprime-mortgage related debt.

“There’s a real game of chicken going on between banks and the corporations as to whether you should tap,” Peters said on a conference call for investors today. “This is a very big deal.”

Even if Tribune, bought by billionaire investor Sam Zell for $8.1 billion in June, taps its entire $750 million credit line, it still may not be able to pay back $1.85 billion of debt maturing in the next two years, the analysts said. They estimate that the amount of cash, cash equivalents and funding available on the credit line currently falls $664 million short…..

Revolving credit lines can be reused once they’ve been repaid. Almost a third of U.S. banks are tightening loan standards and junk bond issuance has dropped 75 percent from 2007 levels, according to Morgan Stanley data. High-yield, high-risk debt is rated below investment grade and known as junk.

“High-yield issuance is a shadow of itself,” Peters said. “The numbers are nothing short of staggering.”

Drawing down on bank lines carries costs for banks and corporations, since they promise unattractive returns, Peters said. Companies that tap bank lines also risk breaking so-called covenants that restrict leverage and face higher interest costs…..

“It’s been mystifying to me all along why Zell chose to be so highly levered given what had been going on in the newspaper industry and in the general economy,” said Robert Broadwater, managing director of the media investment bank Broadwater & Associates in Bronxville, New York. “Having blue jeans, a motorcycle and a foul mouth doesn’t seem to be quite enough to get it done, so far.”

Other high-yield issuers that may need to draw down include Westlake, Village, California-based Dole Food Co., the biggest U.S. producer of fresh vegetables, Cablevision Systems Corp., the New York-area cable television operator, and R.H. Donnelley, the Cary, North Carolina-based phone directory publisher.

Print Friendly, PDF & Email

6 comments

  1. Anonymous

    The fantasy world, beyond derivatives involves magic like this, which shareholders rely on for credit and yield enhancements along with glitter dust and sequins:

    Financial guarantees are contracts that require the issuer to make
    specified payments to reimburse the holder for a loss incurred because a
    specified debtor fails to make payment when due in accordance with the
    original or modified terms of a debt instrument. The amounts in the above
    table are nominal principal amounts.

    ^^ Standby letters of credit which are financial guarantee contracts are
    irrevocable obligations on the part of the group to pay third parties when
    customers fail to make payments when due.

    ^^^ Other direct credit substitutes include re-insurance letters of credit and
    trade-related letters of credit issued without provision for the issuing
    entity to retain title to the underlying shipment.

    ^^^^ Performance bonds, bid bonds, standby letters of credit and other
    transaction-related guarantees are undertakings by which the obligation on
    the group to make payment depends on the outcome of a future event.

  2. Anonymous

    Call it abstract, call it OT, call it financial engineering voodoo, but try to ponder economic entropy and the expansion of Bushonomics 2008 (and beyond) and the exciting fantasy world of chaotic entanglement:

    Quantum entanglement

    http://en.wikipedia.org/wiki/Quantum_entanglement

    Quantum entanglement is a quantum mechanical phenomenon in which the quantum states of two or more objects are somehow linked together so intimately that one object cannot be adequately described without full mention of its counterpart — even though the individual objects may be spatially separated. This interconnection leads to correlations between observable physical properties of remote systems. For example, quantum mechanics holds that states such as spin are indeterminate until such time as some physical intervention is made to measure the spin of the object in question.

  3. Anon

    And so now the banks get to learn that it’s precisely when firms are about to go bankrupt that they decide to draw down those credit lines against which the banks have no capital. (What’s that someone said about all correlations going to one?)

  4. Anonymous

    That seems like a very funny joke that no one will think is funny (ok, maybe a few quants that are still employed)… LOL!

    Re: Einstein famously derided entanglement as “spukhafte Fernwirkung” or “spooky action at a distance.”

  5. foesskewered

    Yves
    Not sure if you’ve seen the opinion piece by Kevin Hassett on the bloomberg site on how the FED seems to have stemmed Bear like problems . Looks like that’s the last of their worries, contagion is starting to push into other oindustroes.Question is could they (banks) rescind these lines of credit?

Comments are closed.