Credit Market turmoil and its effect on the overall Canadian economy
2 August 2007There has been much written on this site and in the media in general about the tumultuous times in todays credit markets. The WSJ excerpt Mark M referenced in his posting yesterday was excellent and really gave good insight into the challenges the large corporates could have in 3-4 years when they try to renew their credit packages if the high yield market has in fact disappeared. A large number of bankruptcy filings with these very large companies are not out of the question.
There is though, a shorter term implication to the broader Canadian (and North American for that matter) mid-market economy if the credit markets continue to stay in turmoil over the near term. By way of example, consider the banking syndicate mentioned in this morning’s Globe who are underwriting the BCE buyout (ie. TD, Citi, Deutsche Bank and RBS). Mr. Sabia mentions the “very, very high quality” financing package that Teachers et al have secured. That means the equity investors have a fully underwritten commitment from these banks to provide a bridge to their high yield offering that will probably be launched a couple of months before the buyout is closed in the first quarter of calendar 2008. The high yield market is almost a binary market – either you can access it @ a cost of 9%-10% or it’s shut down and you can’t access it for any price (think of the tech meltdown in 2000 and all of the CLECs that lost their high yield funding as that market turned). So in the late fall of this year, if the credit market doesn’t settle down and there is no high yield market to access, these 4 banks will be on the hook themselves for the high yield piece of BCE’s new capital structure (probably in the $5B-$10B range). Yes it will be priced probably in the 13%-15% range (which will no doubt throw a wrinkle into the financial model) but the impact to the larger Canadian economy is that because this debt is “riskier” than the senior secured and Term B piece of the capital structure (riskier largely because there will be no asset coverage after the senior secured and Term B is taken care of) these banks will have to allocate considerably more capital to support these loans than they planned on doing. BCE’s banking syndicate put together this “very, very high quality” financing package because they were getting massive fees for this fully underwritten debt package and they took a calculated risk that they could sell off these loans when the time came. Oops, looks like things have changed but then again, “that’s why they pay ‘em the big bucks”.
But back to why this is important to the Canadian “mid-market” economy. If banks have to allocate more capital to underpin these “riskier” loans (which they had no intention of holding), these banks very well could have less capital available to support their general commercial loan portfolio (aka the mid-market). This could lead these banks to a “flight to quality” in the Canadian mid-market which could cause problems for upwards of 50% of their commercial loan portfolios.
So if you are mid-market Canadian borrower (which really means any company who borrows between $250,000 and $50,000,000 from their bank), it’s in your interest to follow the goings on in the credit markets and the particular exposure your bank has to these large buyout deals.
FMU
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