Credit where it’s not due – Part 2
17 February 2007
A few days ago, I wrote about HSBC’s troubled subprime mortgage business. It turns out that Lehman Brothers suspects GM will have to put between $900 and $950 million into GMAC to true-up the selling price for the owners, led by Cerberus. The problem is – yes – the subprime mortgage business and an increasingly lax approach to credit discipline.
That lenders take a more, ahem, liberal approach to credit at times is not news. Subprime mortgages ran into difficulty earlier in the decade, tightened up for a bit and then came roaring back with lenders seemingly camped out at the unemployment lines.
Institutional lending also runs through credit cycles. When you hear strategic buyers complaining that the private equity funds repeatedly pay higher multiples because they can get cheap debt, and lots of it, then you know we might be near the crest.
The main drivers for more aggressive lending would be:
- lenders develop a better understanding of credit risk for the borrower (this would be good, everyone wins. We have become more knowledgeable in a number of areas and advance more credit as a result);
- the fundamentals in the economy and/or the borrower’s business have improved (not as good, because the economy for example could erode over the course of a loan);
- the lender is entering a new market or otherwise trying to win market share (this could be bad for the lender if loans do not adequately price for risk).
But, really, why should a borrower care?
If everything goes well then the borrower shouldn’t care. But you can never know that with certainty.
If things don’t go as planned, which often happens to good growing companies, then I think you want to be part of a lending portfolio that overall is doing well. You don’t want to be part of a portfolio of loans that is struggling. Suddenly the team that was so nice and gave you all of that money on great terms is replaced by one that has to prevent any more losses from mis-priced loans and loose credit discipline. And that can’t be fun for the remaining borrowers.
I am willing to bet that someone on the edge today with and HSBC or GMAC mortgage is having a tougher time of it than someone in the same position with a healthier lender.
We have seen some transactions lately, some senior debt deals in particular that I can think of, that could turn into headaches in the future for borrowers if things don’t go well. I’ll be watching those to see if my hunch is right.
CWN
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