By William Patalon III
Executive Editor
Money Morning/The Money Map Report
As a result of the U.S. credit crisis – and the near-shutdown of the commercial lending market – investors can expect the Corporate American landscape to change in a big way over the next 12 months.
Although bank-to-bank loan rates fell for the sixth-straight day yesterday (Monday) – decreasing fears that the corporate-lending market was going to seize up – a new reality has emerged: As the song says, “only the strong will survive.”
Strong companies will navigate the uncertainties of the markets in the months and years to come; weaker players will falter, fall into bankruptcy, and get gobbled up by larger, more-healthy companies.
“This is unequivocally, absolutely, positively” the new reality, says R. Shah Gilani, a retired hedge-fund manager and Money Morning contributing editor who has emerged as a top expert on the global credit crisis. “And the unspoken reason is that even after the credit crisis has been alleviated, it will not be over.”
If the credit markets continue to improve as they have been over the past week or so, then the more-creditworthy companies should discover that loans are easier to get, and carry a lower interest rate. As Money Morning has been reporting, the London Interbank Offered Rate (LIBOR) – a benchmark rate for short-term loans – has been dropping. Yesterday, LIBOR for three-month dollar loans fell for the sixth straight day, declining 0.36 percentage points to reach 4.06%.
The recent decline in LIBOR — which establishes lending costs for individuals and for businesses — reflects a growing trust in the financial sector after governments around the world have guaranteed billions of dollars worth in bank debt and have also unveiled plans under which they will buy stakes in weak and foundering banks.
“The general economy was weakening, and that weakening has taken a turn for the worse,” Robert DiClemente, an economist at Citigroup Inc. (C), told The Associated Press. “And any company that was already facing more-challenging business conditions, when they're confronted by tighter credit, it gives them one less degree of flexibility.”
Take the U.S. auto industry, which is in a power slide and headed for a cliff.
Burning Rubber – and Cash
The No. 1 U.S. automaker, General Motors Corp. (GM), has been burning through more than $1 billion per month, and now wants to buy Chrysler Corp., in order to access the privately held automaker’s cash hoard. But in the current credit environment, raising the financing for the merger of two companies that have been generating billions of dollars in losses and burning through cash like a California wildfire burns through acreage is tantamount to financial alchemy. GM’s initial attempts to secure financing for the controversial merger have been rebuffed, raising new doubts about whether the buyout can be completed without government aid, Reuters reported late yesterday.
“It's like a Kabuki dance,” a source familiar with the talks told Reuters. “Everybody already knows the outcome. They are going to have to go to the Fed for money.”
another person familiar with the talks said. “Everyone already knows the outcome. They are going to have to go to the Fed for money.”
GM Chief Operating Officer Frederick A. “Fritz” Henderson and the executive team leading talks with Chrysler's majority owner Cerberus Capital Management LP believe GM can strike a deal to pick up Chrysler's best assets and shore up its own cash position in the process, the news service said.
Chrysler has $9 billion in debt that would have to be paid off immediately if it can’t be refinanced, thanks to a “change-of-control” provision the debt carries. Additionally, a cash-strapped GM needs between $4 billion and $5 billion to shutter most of Chrysler’s 14 assembly plants and to finance the severance packages for the estimated 30,000 to 40,000 jobs that would be eliminated because of the merger, reports state.
GM is drooling over Chrysler’s war chest of cash – about $11.7 billion as of June 30 – which it could grab with the merger’s completion.
Some would have to be used to pay off Chrysler’s debt, if it isn’t restructured – an action that is also expected to be challenging. GM had about $21 billion in cash on hand as of Jun 30, but is burning through that cache at a rate of $1 billion a month.
General Motors execs believed the automaker would be able to make it through 2009 by raising as much as $5 billion through a combination of borrowing and asset sales. But the locked-up credit market made this an almost-impossible task. To put that additional funding in perspective, GM's market capitalization was only $3.7 billion as of Monday.
Short-Circuited By Financing Problems
GM isn’t the only company having trouble nailing down the funds it needs to hold on until they can work out their other problems. For instance, Circuit City Stores Inc. (CC) is preparing to close a fifth of its stores and cut thousands of employees to avoid filing for Chapter 11 bankruptcy protection, The Wall Street Journal reported yesterday.
According to The Journal, Circuit City has retained investment bank Rothschild Inc. to talk to banks and get emergency financing.
On positive side of the financing coin, Finmeccanica SPA (PINK: FINMF), the Italian defense contractor that's buying U.S. electronics maker DRS Technologies Inc. (DRS), yesterday confirmed its full-year targets and said its “strong” finances will enable it to shrug off the global credit market crisis.
“We confirm our guidance [for 2008 and 2009],” CEO Pier Francesco Guarguaglini told Bloomberg News during an interview at the company’s Rome headquarters yesterday. “We don't see a slowdown in the Italian defense budget.”
Finmeccanica won't feel the effects of the global financial turmoil and expects governments to step up defense spending, Guarguaglini said during a news conference earlier in the day.
The defense contractor started a $1.33 billion (1.2 billion-euro) share sale yesterday. That's part of the company's funding plan for the $4 billion acquisition of DRS, which includes selling bonds and divesting a piece of its Ansaldo Energia power-plant unit. The company expects to complete the acquisition of DRS in about 10 days, Guarguaglini said.
Finmeccanica makes fuselage panels for the Airbus SAS A380 superjumbo and also sections for The Boeing Co.'s (BA) 787 Dreamliner. The Italian company has also a contract from Lockheed Martin Corp. (LMT) to supply the U.S. presidential helicopters.
LIBOR Lessons
The LIBOR decrease has helped ease some investor demand for U.S. Treasury bills – considered the ultimate in safe investments. The yield on the three-month T-bill surpassed 1.0% for the first time in nearly two weeks, rising to 1.12% yesterday from 0.82% late Friday.
The U.S. Treasury Department auctioned $25 billion in three-month bills at a discount grate of 1.25%, up from 0.50% last week, and another $26 billion in six-month bills at a discount rate of 1.80%, up from 1.10% last week, The AP reported. Those higher rates for short-term government debt suggest “continued healing in the credit markets,” Tony Crescenzi, an analyst with Miller Tabak & Co. LLC., wrote in a research note to clients yesterday.
As investment funds slowly take money out of safe assets, they are turning to assets that carry a bit more risk – presumably for a better return.
Indeed, Miller Tabak’s Crescenzi noted that yesterday’s mortgage-backed securities market signaled “increased risk taking.”
And the market for commercial paper — the unsecured debt that companies sell for short-term financing — continued to improve. Commercial paper rates were generally down 0.20 to 0.40 percentage points for key issuers tapping the market Monday, including American Express Co. (AXP), General Electric Co. (GE), HSBC Finance (ADR: HBC), AT&T Corp. (T) and The Coca-Cola (KO), Kevin Giddis, managing director of fixed income at Morgan Keegan & Co. Inc. (RF), told The AP.
Just a few weeks ago, even stronger companies like AT&T were having trouble selling paper for longer than overnight. Now, investors are starting to step in and buy paper with 30-day and 60-day maturities, Morgan Keegan’s Giddis said. On Oct. 27, the Federal Reserve is scheduled to start buying commercial paper from issuers that can't find buyers in the market. [Check out Money Morning’s report on the near seizing of the all-important commercial paper market, part of an investigative series on the credit crisis published by this global investing news service.]
Against this still-slightly-uncertain credit-market backdrop, companies are going out of their way to broadcast their financial strength – and ability to be financially flexible – to the capital markets.
For instance, engineering-and-construction giant The Shaw Group Inc. (SGR) said it was able to amend its credit facility so it can use up to $200 million as collateral for letters of credit. Trucking company Werner Enterprises Inc. (WERN) emphasized that it is a “debt-free company.” And U.S. toymakers Mattel Inc. (MAT) and Hasbro Inc. (HAS) both underscored they have little debt on their books and have plenty of cash available.
Even so, both Werner and Mattel conceded that they may feel the credit-crisis pinch – albeit indirectly – because so many of their suppliers and customers have not been able to obtain financing of their own.
In its third-quarter earnings report, Werner stated that “unless freight and financial market conditions improve quickly, Werner believes there is a higher probability of increased carrier failures.”
During a quarterly call with investors, Mattel CEO Robert A. “Bob” Eckert said that “retailers are reluctant to make inventory bets, and it will be difficult for some of our customers and vendors to obtain the funds they need to buy inventory or raw materials.”
That’s not good news – for suppliers such as Mattel, or for retailers – with the all-important holiday shopping season looming just around the corner.
In other Treasury trading, the two-year note saw its yield surge from 1.63% Friday to 1.71% yesterday. The 10-year note yielded 3.87%, down from 3.97%. The 30-year bond yielded 4.26%, down from 4.34%.
News and Related Story Links:
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Money Morning Market Analysis:
LIBOR Drops But Short-Term Credit Markets Remain Tight. -
Walla Walla Union Bulletin:
Bank-to-bank loan rates fall for sixth day.
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Bloomberg News:
Finmeccanica to Meet Financial Goals, Withstand Credit Crisis. -
Reuters:
Chrysler deal threatened by financing. -
Wikipedia:
London Interbank Offered Rate (LIBOR). - Wikipedia:
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Wikipedia
: Mortgage-Backed Securities. -
Money Morning Investigative Series:
Credit Crisis Update: An Inside Look at the Commercial Paper Debacle.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.