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July 26, 2007

Tightened lending from subprime crisis has ripple effect

For example, skittish lenders are demanding that Cerberus Capital dig up $2 billion in cash to help pay for its acquisition of Chrysler.

Other fallout? GM’s sale of Allison Transmission is on hold; so is KKR’s plan to buy electric utility TXU. Expedia’s desired stock buyback was cut by 80 percent, by number of shares, because it couldn’t raise the necessary loans.
What do investors want? Higher rates and stiffer covenants governing what a company can or can’t do with the money. In the last year or so, buyout firms have been able to sell lots of so-called covenant-lite bonds — bonds with virtually no conditions attached.

But now that investors are cooling to those deal terms, investment banks have to lend the money themselves, in what are called bridge loans, to make deals happen.

Investment banks don’t like being in that position because they are hired to find money, not to lend it. Lending money ties up capital that could be used for other deals. And that means other deals have to wait.

But they are doing it. JPMorgan’s Dimon told analysts last week that banks have committed to take $100 billion on bonds on deals and to make $200 billion in bridge loans so deals can close.

The root of the crunch isn’t corporate deals. Instead, it’s a result of the subprime mortgage mess. Banks gathered huge pools of mortgages, then sold securities backed by the loans that reflected the risk tolerance of various investors.

With many homeowners defaulting on their mortgages, big investors are worried they’ll never see their money again. They want more before financing anything that smacks of high risk: The yield on a typical midgrade bond has jumped from 6.9 percent to 8.6 percent in a month, according to the Telegraph newspaper in London.

Here’s the bottom-line question: How much will this affect economic performance in the next 9-12 months?

I think it’s going to be minimal, in and of itself. Maybe 0.2 percentage points. But, combined with other factors, that can add up. It depends on how much of an inflationary ripple this has.

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