Credit crunch

  • Date:01 Nov 2007
  • Type:CompanyDirectorMagazine

The US subprime crisis has pushed up the cost of debt as nervous lenders have pulled back on their lending. ANZ head of credit research, markets, Sarah Percy-Dove provides some tips on how to manage a credit crunch.

Easing the credit crunch’s sting

Volatile markets unsettle investors. So it is no surprise that debt investors, both bank and institutional, are rattled. Having taken the brunt of the US subprime fallout with painful losses, they have stepped back from the markets and liquidity has evaporated.

Liquidity crunches typically close access to credit to all but the ‘best’ corporates. Interestingly, these companies are not always the biggest or the most highly rated. They are usually companies which debt investors are very comfortable lending to – they are considered to epitomise ‘best practice’ and have a strong relationship with the debt community.

What does such a company look like?

  • They are rated by the major ratings agencies;
  • Management is well known to, and accessible by,
    credit analysts;
  • They hold separate briefings for debt investors;
  • They understand the concerns of debt investors and address these issues;
  • They know who owns their paper; and
  • In tough times they increase disclosure.

Assuming the markets are open to your company, there are a number of ways which may moderate the cost of funding.

Investors will give up spread for well structured deals, so consider providing covenants. By this I do not mean a Change of Control or Negative Pledge clause, which have become non-negotiable in new deals. But rather, a well structured covenant package includes maximum debt and minimum coverage maintenance tests, limitation on asset sales, limitation on secured debt, make whole clauses and penalties for a downgrade in ratings.

How much are investors willing to give up? It’s deal dependant, but somewhere from 3-10 basis points could be attainable.

Guarantees also provide credit support, so if you have a parent, consider getting them to provide a downstream guarantee. Also, as large creditors do not like being subordinated, provide upstream guarantees from your major subsidiaries. That way unsecured creditors at subsidiaries are not senior to the holding company lenders. Upstream guarantees may also offer some relief in addressing issues raised by the Sons of Gwalia case.

Diversifying funding sources can also lower funding costs. Most Australian corporates do not have a strong relationship with bond and private placement (PP) investors because they haven’t had to. After the US subprime meltdown, this strategy could be revised as Australian fund managers are forecast to have some US$2 trillion in funds under management by 20151. On average, 17 per cent is invested in fixed income assets, or about US$340 billion. That’s a lot of money that needs to be invested and bonds and loans are a sought after asset classes.

Bond & PP investors can also offer longer tenor than banks with US PP investors, in particular, able to lend up to 30 years. With Australian borrowers almost universally ‘short’, if you have an average loan life of less than say, three years, you may want to consider extending maturity.

All the time and effort building relationships and moderating costs can be for nought if you miss-time the market. Given the multitude of events which can instantly move prices, it is important that you are opportunistic. Often there is just a short window when an issuer, investors and the markets all align and a deal can get a deal printed. So it is crucial to have access to current and insightful market information. The best way to do this is to maintain a regular dialogue with originators and analysts. Always know where the latest deals print and constantly seek colour about what investors are thinking.

Finally, the price of debt is where the market will buy it on any particular day. Of course this price today should be assessed against where it could price tomorrow. However, where it was priced last week, last month or last September is irrelevant in the context of today’s environment.