From the May 2008 issue of Treasury & Risk magazine

Crunch Time for Treasury Financing

"I would not want to be negotiating bank credit right now," observes Greg Weigard, assistant treasurer at $10 billion Air Products & Chemicals Inc. Like other farsighted treasury managers, he made sure he wouldn't have to. Weigard's treasury team reevaluated the Allentown, Pa.-based company's multi-year credit facilities while they still had a couple of years to go and entered renegotiations when the market was favorable. Air Products currently has a five-year syndicated revolver for $1.2 billion with 15 banks that it renegotiated in 2006, so the company is protected until 2011 and none of the credit is drawn. Weigard is fortunate, but hardly alone. The treasury department at Honeywell International Inc. locked in a fairly robust $2.8 billion of bank credit last spring--when credit conditions were favorable--expanding the commitment by $500 million and locking in the deal until 2012. The current credit crunch is "the deepest one I've experienced," says Jim Colby, assistant treasurer at $34 billion Honeywell. "This one has a run-on-the-bank mentality. If your credit quality becomes tainted and you haven't tied down your financing with long-term committed facilities, you'll have a tough time raising money today." At year end, Honeywell carried $7.7 billion of debt on its books, none of it bank debt. The bank facilities just back up its commercial paper programs, he explains.

Managing bank credit relationships during a credit crunch is, of course, a lot more complex than locking in long-term commitments and then relaxing. For every Air Products and Honeywell out there, there are many others whose funding needs are or will be impacted by the ongoing turmoil in the credit markets. But there are ways to mitigate the damage. Treasury managers everywhere who rely on bank funding are finding that anticipation is the key to getting through a monster credit crunch and a worsening economic downturn, whether it means locking in credit commitments for the long haul, dealing proactively with loan covenants or helping bankers through their capital squeeze.

Managing covenants is now becoming a hot-button issue for many companies starting to feel the pinch of a recession. The right time to deal with a covenant violation is well before it occurs. Yet "most companies do a terrible job of anticipating covenant violations," says James R. Simpson, a corporate debt management consultant and managing partner of Corporate Finance Solutions LLC, Stamford, Conn. He cites a recent survey of 400 treasuries that found that 25% admit to having no formal process for managing financial covenants proactively. Even worse, 44% concede that they have no financial model to forecast covenant violations. "As a practical matter, that means that 44% don't really have a credible process for anticipating covenant problems," he insists.

Even companies that lock in long term commitments need to keep track of their covenants, since violating a covenant, especially during a serious credit crunch, is very bad news. "If I find out shortly after a quarter ends that I breached a covenant--say my debt to EBITDA ratio--during that quarter, I'm already in technical default, and that changes the whole conversation," Simpson points out. "By not anticipating the breach and negotiating with my bankers early, I've tied their hands and given them all the power in the negotiations that must occur. You might get away with it in good times, but bankers now are in no mood to be forgiving." It damages the reputation of your management and your risk monitoring. And on top of that, it raises audit issues and could violate Sarbanes-Oxley compliance, he adds.

On the positive side, Simpson, who was a CFO of a highly leveraged company during a previous credit crunch, cites the example of a New Jersey client who could see last October that there might be problems with its interest coverage covenant in the first three quarters of 2008. So that client quickly called its lead bank and explained the prospects. The bankers appreciated the heads-up, looked at the forecast and stress test and got agreement from syndicate members to amend that covenant for those three quarters. No breach occurred. The cost was minimal, and the borrower never lost negotiating power, he notes. "The bankers saw that the company really understood its business and didn't want to embarrass the account officer. They like to work with companies that can anticipate business changes," he says.

Just how bad is the market? It's virtually impossible now to get no-covenant or light-covenant deals. Spreads have widened substantially, making credit ratings more important. And borrowers in today's market need to think small. "It's time to be realistic about the size of facility you can expect," Simpson suggests. Covenants will be tight, and borrowers need to be sure that those that ratchet up will be sustainable over the life of the credit, he says. And any bank deal today will take time to pull off. "Negotiations are just harder and slower. Allow at least a month longer than you would in a normal credit market," he suggests.

Spreads in the investment grade bank loan market are lagging behind widening spreads in the credit default swap market, but they're likely to catch up, predicts Meredith Coffee, director of analytics at Loan Pricing Corp., New York. Many investment-grade loans include a five-year tranche and a 364-day tranche, she notes. Bullish lenders had been easy with five-year loans, but now borrowers are seeing a lot more 364-day loans. If you want to upsize, you'll probably have to do it in the 364-day space, she says.

The secondary market is also rocky. In leveraged loan trading, senior secured paper tends to be stable under normal market conditions and sell for no less than 99 cents on the dollar, Coffee points out. "Even in modest economic downturns, this debt was considered good money," she observes. But in this crunch, these senior secured leveraged loans fell in lockstep with junk bonds, and the average bid for such loans is around 89 cents on the dollar. "That's worse than we saw in 2002, when default rates were much higher," she observes. "The buyer base is disappearing, and the whole asset class is under a cloud of uncertainty. This is fundamentally different than we saw in other economic downturns," she adds. Of course, those who pushed their banks to lengthen their agreements are glad they did. "We have actively requested extension options in our credit agreements and have used them to push out the maturity date as far as possible," notes Michael Watts, assistant treasurer of the $6.8 billion Eastman Chemical Co., Kingsport, Tenn. He didn't need a crystal ball. "No one could have anticipated the specifics or known that this downturn would be so severe, but we suspected that the economy would slow down sooner or later, and we try to keep open our access to bank credit as long as possible," Watts says.

Companies that didn't extend maturities when they could, especially those with credit "issues," says Honeywell's Colby, will wait out the crunch if they can. If they can't, they'll have to settle for 364-day facilities and be "flexible" about the pricing they accept. "It's a very hard time to get extended commitments," he notes. Colby cites some corporations and financial institutions that levered to acquire long-term assets without locking down committed funding, and now they are caught in a real bind. They have assets they can't liquidate quickly in this market, and they are having difficulty getting funding. So they get headlines. "This underscores how important it is to have a solid liquidity management system in place," Colby emphasizes.

Just how much liquidity a large back-up facility provides is open to question, of course. A company can always draw on its back-up credit lines if it can't sell the CP it needs, Colby notes, but that is something most companies prefer to avoid. "The rating agencies don't like it, and the banks will hold it against you the next time you have to renegotiate your facility. It's something you'd typically avoid doing," he explains.

Air Products has no interest in using the credit crunch to help strapped companies in its supply chain, Weigard says. "Our balance sheet is precious to us. We're not a bank, and we would avoid doing things like paying early because we have access to funds." If Air Products had to finance something like a major acquisition, it would probably arrange a bridge facility with its relationship banks and term out the money over time in the bond markets. Weigard is confident of access to bank financing as long as Air Products keeps its solid investment-grade credit rating.

While a credit crunch can certainly turn corporate borrowers and their credit bankers into adversaries, that's not the way to go, the experts agree. "Try to strengthen relationships," Coffee advises. "Look for all the ancillary business you can offer your banks" to sweeten the deal. Eastman Chemical's Watts looks for ways to further existing banking relationships. "In times like these," reports Watts, "with banks under so much pressure, we pay even more attention to how we allocate noncredit business to our banks and make sure we give each piece to the bank that would value it most and align the noncredit business we award with the credit support that bank is providing." Eastman has two bank revolvers, a $700 million domestic one with 15 banks and a $200 million euro-denominated one in Europe. JPMC and Citi are co-leads. Both have four to five years to go before maturity, and that is no accident. Air Products uses its $1.2 billion syndicated revolver to support an A1/P1 commercial paper that currently has $400 million outstanding.

Be sensitive to how you affect the capital pressures banks are grappling with, Coffee recommends. "Balance sheet capacity is definitely scarce," she observes. Many banks are having to raise new capital, shrink their balance sheets or both. An unfunded credit commitment requires less capital than a funded loan and is therefore easier for a bank to provide, she points out. And a 364-day commitment consumes less bank capital than a longer-term one. The queasy secondary market is forcing banks to hold onto loans they always intended to sell, swelling balance sheets and putting more pressure on bank capital ratios.

"More than ever, this is a time you want to have strong bank relationships to draw on," Colby concludes. "If you did well by your banks during good times, they'll probably stand by you."