Companies Feel Consequences Of Borrowing For Short Term
By Henny Sender, 10/12/2001 The Wall Street Journal
That is the strategy many companies seem to have taken as short-term interest rates steadily fell to record low levels during the year. The rates were falling as many companies found themselves under pressure to meet earnings targets, and one seemingly pain-free way to avoid disappointing shareholders was to boost the levels of short-term debt over long-term debt.
It worked. Because short-term rates fell further than long-term rates this year, especially during recent months, the strategy of shifting to shorter-term debt paid off. Dependence on the short-term corporate IOUs known as commercial paper could save a company treasurer as much as $50 million annually in interest compared with the cost of issuing $1 billion in debt in the bond market.
But amid economic uncertainty heightened by the Sept. 11 terrorist attacks, the downside of that strategy is becoming apparent, as companies find they have sacrificed financial flexibility.
Just as that commercial paper needs to be rolled over, other sources of money -- banks and the bond markets -- aren't that hospitable.
Bank lending to commercial and industrial companies began a steep decline at the end of the first quarter, and, for the past 13 weeks, it declined at an annualized 8% rate, according to data from Fuji Futures. Companies whose cash flow has been reduced by the weakened economy face hurdles in turning to their banks for help. Reduced cash flow may put these companies in violation of certain performance standards that banks require to maintain credit lines, even as banks are become more risk averse, raising the chance they won't extend new lines.
That means that all potential sources of capital -- money markets, banks, bond markets and equity markets -- are being hit simultaneously by heightened nerves after the terrorist attacks. "Unless you have at least a triple-B rating, there is no bank market and the bond markets are also shut," says Jim Millstein, a managing director at Lazard Freres & Co. in New York. "There is no liquidity for companies on edge."
Jonathan Ezrow, a managing director in Credit Suisse First Boston's high-yield finance department, says: "Lots of heavily levered companies are facing a new macro environment, and now the line between those who can finance and those who can't has moved."
"I used to tell clients that to lock in long-term money is smart, and they'd say, `We know [the three-month London Interbank Offered Rate] won't stay here forever, but it hurts to replace cheap money with 8% or 9% money. A couple of pennies more in earnings feels so good,' " Mr. Ezrow says.
Even before Sept. 11, issuance in the commercial-paper market was becoming a problem for second-tier companies. As of late September, there was $75 billion of commercial paper outstanding for second-tier companies, down from a high-water mark of $145 billion last year according to Federal Reserve data. The shrinkage has been accompanied by widening between the rates paid by top-rated borrowers and second-tier credits. Top-tier issuers were paying 2.54% for 30-day commercial paper the first week of October, while second-tier issuers paid 15% more, or 2.92%. In contrast, during the first week of September, first-tier companies paid 3.50% and second-tier ones, 3.67%, a difference of just 5%.
A broad swath of companies -- automotive-parts suppliers, construction companies, broadcasters, retailers and transportation businesses -- face the tougher commercial-paper market looking more vulnerable than they did just months ago. Hurt by the economic slowdown, their cash flow is shrinking. And "lower cash flow gives rise to a whole new round of concerns," says George Meyers, senior credit officer for Moody's Investors Service.
Take car-parts maker Dana Corp., whose debt was downgraded a few months ago. "I thought they had a very short-term capital structure for a company their size," says Lisa Matalon, an analyst with Moody's who specializes in assessing downgraded companies. "There were a lot of questions about how they let it happen."
For the quarter ended June 30, Dana had $2.5 billion in long-term debt and more than $2 billion of short-term debt. Its net income for the period was down 90%, a result of what the company called "low and erratic" production by auto makers.
Dana was able to refinance a portion of its short-term debt with a $750 million privately placed bond issue in August; the company declines to reveal the terms publicly. Worries also aren't over at Granite Broadcasting Corp., which raised $205 million in a three-year offer in March, paying investors more than 12%. The New York broadcaster was downgraded by Moody's in July, nevertheless, because of the high debt-service requirements on its $400 million of debt and "substantial refinancing risk," even though the company has no debt falling due for the rest of the year and $50 million in cash.
"We have a balance sheet which needs tending to," says W. Don Cornwell, the company's chief executive. "We planned for a bad year and the year is worse than we had planned." Like most broadcasters, Mr. Cornwell is renegotiating bank covenants as his company's financial performance falls short of targets. In addition, during the past week, Granite announced that it retained Goldman Sachs Group Inc. to advise on asset sales to "keep the company ahead of the game," he says.
It isn't always clear which companies are most vulnerable. Balance sheets may be misleading because commercial-paper obligations aren't always reported. "If there are long-term bank lines backing up the commercial paper, then it doesn't show up under current liabilities," says Carol Levenson, founder of GimmeCredit, a Chicago research boutique.
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