In our current environment of tighter credit, borrowing money has become harder for many companies, causing them to tap their revolving credit lines with banks. Meanwhile, some lenders will likely struggle as they try to keep up with their obligations, leaving the financial industry more strained. (Not having imagined today's scenario, they probably didn't expect many firms to be drawing on those credit lines.)
Financial Week dove into this development, listing many companies that have been tapping their revolving credit lines recently. For example:
|
Company |
Borrowed (millions) |
Credit Line (millions) |
|---|---|---|
|
eBay (NASDAQ:EBAY) |
$1,000 |
NA |
|
Lear (NYSE:LEA) |
$400 |
$1,700 |
|
Gannett (NYSE:GCI) |
$1,200 |
$3,900 |
|
General Motors (NYSE:GM) |
$3,400 |
$4,500 |
|
American Electric Power (NYSE:AEP) |
$1,400 |
$3,000 |
|
Sally Beauty |
$75 |
$400 |
|
Goodyear Tire (NYSE:GT) |
$600 |
$1,500 |
Source: Financial Week.
How did we get here?
The problem is that most of these revolving credit lines were established in our previous economic environment, when credit was much more available. Interest rates were low (they still are), and the credit line terms were generous. Lenders didn't expect companies to take advantage of the lines, as the companies had plenty of alternatives. They could, for example, issue more stock shares, or bonds.
With the market depressed now, it's not a rosy time to issue stock; companies aren't likely to fetch high prices for their shares. The bond market isn't what it used to be, either, with companies often finding they have to offer high interest rates. Credit lines are thus looking attractive as a place for companies to grab some money to meet their needs.
Given current circumstances, I wouldn't be surprised if some companies are tapping their revolving lines even before they need to, just to ensure that they have cash on hand. This could generate a vicious circle, with the borrowing pressuring lenders, which worries other companies, which then draw on their lines, too.
What else?
Here's another possibility: With the economy and many companies sputtering, some companies may be tapping their credit lines prematurely because they worry about having trouble borrowing later, either because their lenders try to cut their credit lines or because their own financial performance has slumped.
Indeed, various lenders have been actively working to reduce their credit line exposure, taking opportunities (such as refinancing) to shrink or even eliminate some lines. Citigroup, for example, recently showed a 15% drop in its corporate loan portfolio in its third quarter, compared to a 27% increase a year ago.
Another way that lenders are looking to reduce their obligations is by selling them. Just as mortgage-backed securities were packaged and sold, revolving credit lines are now being offered on the secondary market. However, as they're not so attractive, they're not drawing many drooling buyers, so they're ending up as parts of bigger packages.
What to do
We investors need to be on the lookout for how our companies are using their credit lines. When we see them tapping the source, we might ask whether it's being done as extra insurance or because a company sees itself in danger and is taking the only capital it can access.
If you'd like to be as far removed from this revolving door of credit panic, consider looking for companies with plenty of cash and little to no debt. You might screen for companies with low debt-to-equity ratios, for example. A company like Paychex (NASDAQ:PAYX) might appeal, with its debt-to-equity ratio of zero, along with more than $3.7 billion in cash and a dividend yield topping 4%.
At some point, the credit crunch will end. Until then, watch out for companies that are testing their limits.
