The Wall Street Journal-20080122-Credit Scare Spreads in U-S-- Abroad- Loan Terms Tighten For Smaller Businesses- Recipe for Slower Growth
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Credit Scare Spreads in U.S., Abroad; Loan Terms Tighten For Smaller Businesses; Recipe for Slower Growth
The credit crunch that was sparked by problems with residential mortgages is spreading to the broader economy -- with banks making it harder and more expensive for some small and midsize businesses to borrow.
While companies with strong balance sheets still can borrow what they need at good rates, others are beginning to feel the chill. In particular, start-up and smaller companies are finding that banks are setting higher rates, seeking more collateral or lending smaller amounts.
This is the way it often unfolds when there is a squeeze on lending. The last significant credit crunch, which ran from about 1989 to 1992, began with a pullback on lending for commercial real estate that then spread to business lending. This time, the problems spread from residential real estate and are being felt by everyone from commercial orchid growers in Florida to makers of heavy machinery.
"The credit crunch is definitely creeping into the broader economy -- the only question is how deep and for how long," says John Graham, a finance professor at Duke University's Fuqua School of Business who coordinates surveys of chief financial officers at U.S. companies. Small and midsize companies are being hurt most, he says, although big companies with poor credit are hit as well.
With other indicators pointing toward a possible recession -- including falling stock prices and rising unemployment -- a widening credit crunch doesn't bode well for the economy. Start-ups and small businesses are generally the companies that create jobs in a downturn. But tighter credit could curb business investment and hiring as companies recalculate the costs of investing in new machines, marketing campaigns or ventures. This could magnify the current slowdown in growth.
"More-expensive and less-available credit seems likely to impose a measure of restraint on economic growth," Federal Reserve Chairman Ben Bernanke said last Thursday in testimony before Congress.
In conference calls to investors last week, banks from J.P. Morgan Chase & Co. to PNC Financial Services Group Inc. said they have been exercising more caution with commercial real estate, construction and other loans. San Francisco-based Wells Fargo & Co. said last Wednesday that it is reducing the maximum amount that some small-business owners can borrow from a unit that specializes in unsecured loans and credit lines that average less than $20,000. The next day, Seattle-based Washington Mutual Inc., which reported a fourth-quarter loss of $1.87 billion largely because of mortgage woes, said it is getting tougher on commercial borrowers.
Another indication that the cost of borrowing is rising for all but the most blue-chip businesses: The yield on junk bonds, which represent high-yield loans to borrowers with weaker credit, has risen to 10.16% from 7.53% a year ago, according to Merrill Lynch. Top-rated borrowers, meanwhile, are actually paying lower rates -- 5.27% versus 5.58% a year ago -- as a result of the decline in Treasury yields, which have fallen more than twice as much.
In some ways, lenders are returning to more-normal standards. "Twelve months ago, it was like the wheelbarrow of dollars was sitting out on the street unattended," says Richard DeKaser, chief economist at National City Corp. in Cleveland. "So credit has unambiguously tightened," but that isn't necessarily a bad thing.
Overall, lending to businesses has actually increased in recent months. But that's not due to easy credit. Commercial and industrial lending by commercial banks in the U.S. rose to $1.45 trillion as of Jan. 9, on a seasonally adjusted basis, up 13% from July and the start of the credit crunch, according to data from the Federal Reserve. Much of that increase can be attributed to banks that were forced to absorb debt that they couldn't sell in secondary markets, and the impact of companies drawing down lines of credit when other types of financing started to dry up.
A recent survey by the National Federation of Independent Business found that 7% of the small-business owners surveyed in December said they were having problems getting financing, up from 4% in November. "I'm sure that everybody is being a little more careful. Certainly the banks that were aggressive are being more careful now," says William Dunkelberg, the federation's chief economist.
Mr. Dunkelberg adds that he thinks customers of institutions that are exposed to the risky subprime-mortgage market -- and to instruments that made bets on it -- are having the most trouble securing loans. "For community banks, which is where many smaller businesses do their banking, there's less of that because they weren't into the crazy stuff in the first place," he says.
But some smaller banks are exercising caution as well. William Bachman, a manufacturer who sits on the board of Bremen Bank & Trust Co. in St. Louis, says he has seen a clear change in tone of the bank's loan-application reviews in the past two months. "It's not like someone announced, 'Now we're going to start looking harder at these,' it's just the group evolved toward doing that," Mr. Bachman says.
Recently, he said, a customer who had been banking at Bremen for 15 years applied for a loan of about $4 million. The loan was granted. But, because the borrower was planning to use the money to buy a piece of equipment to serve a highly leveraged customer, the bank went the additional step of asking the customer to personally guarantee the first $1 million of the loan.
"I don't think that would have happened a year ago," says Mr. Bachman. In a few cases, he adds, the bank has also started asking for life insurance policies to serve as loan collateral for small-business owners.
One company facing tightening credit is Terex Corp., a Westport, Conn., producer of road graders, excavators and other heavy machinery for mining and construction. Its chief executive, Ronald DeFeo, says the company, with $8.5 billion in annual revenue, anticipated tightening credit several months ago. So it raised $800 million last fall from the sale of high-yield bonds. The company, whose credit rating is below investment grade, has tapped those funds for acquisitions of two equipment makers.
Mr. DeFeo figures securing new financing would cost him more now. Terex and other heavy equipment makers, including Caterpillar Inc. and Deere & Co., have seen their stocks hammered as investors fret that a potential recession will hurt equipment manufacturers. It hardly matters that Terex does 60% of its business outside the U.S., says Mr. DeFeo. "People just assume that if there's a U.S. recession, then that means customers can't access capital, so you'll sell less."
Rich Kalsi, chief executive of Capital Cooking Equipment Inc. in Santa Fe Springs, Calif., which builds high-end ranges, hasn't seen any problems. In fact, Mr. Kalsi says, his bank already has approached him, asking what his needs would be in the coming year, as his company exports more ranges to Canada and Australia, aided by the weak U.S. dollar. "We're launching three or possibly four new products, so we certainly need their help," he says. "They've been very accommodating."
Then there are those like Kerry Herndon, owner of Kerry's Bromeliad Nursery Inc., a commercial orchid grower in Homestead, Fla. He says banks won't even talk to him about new loans, because the big hurricanes of a few years ago caused heavy damage to his greenhouses and cut his profit. "My goal right now is to just keep the credit I have," he says.
But he says he's frustrated because the current downturn has offered opportunities he says he's had to forgo. "There are at least three companies in my industry that are on the market right now at very good value that I'd like to look at buying," he says. "But I can't get any financing to do any deals."
In one case, Mr. Herndon says, he even approached the bank that was pressing one of these companies to find a buyer and offered to try to work with them on a financing package, but was shunned.
"My own bank is like: 'Come to us with something really small and we'll try to work it out,'" he says.
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Rick Brooks contributed to this article.
(See related article: "Fears of a Recession Spark a Global Selloff; New Pressure on the Fed" -- WSJ Jan. 22, 2008)
