Look Around - The Credit Crunch Has Arrived

Includes: BMO, BSC, C, CM, FIG
by: Mark McQueen

News flash: the credit crunch is finally here.

I was part of a panel with Joe Mattina of Fortress (NYSE:FIG) in January and we were asked about the “credit crunch.” I challenged the audience to name a single Mega LBO deal that had been pulled at the behest of nervous U.S. lenders. Not that a credit crunch wasn’t coming, it just hadn’t arrived at that point (see prior posts including “News flash!: Dead Tree Media unearths connection between subprime and corporate debt” June 27, 2007; “BNN interview on trials in the corporate credit market“‘ July 25, 2007, “‘Panic’ sets in to the debt markets” July 29, 2007 and “Credit Market turmoil and its effect on the overall Canadian economy” August 2, 2007).

Most decent mid-market deals were - at that time - still seeing four or more termsheets on any given financing opportunity. The DTM folks were confusing subprime mortgage mayhem and the seizing of the ABCP market with a lending crisis. It was coming, but not quite yet.

The panel setting was a Montreal commercial finance conference sponsored by The Canadian Institute, and no one in the audience could think of a single situation. More people have claimed to have seen the Loch Ness Monster. But that was 6 weeks ago; and times have changed.

Although I still can’t name any pulled Mega LBO loans, that line of reasoning has become a red herring. The signs of a skittish credit market are now popping up. Late last month, Crossfire’s [CFE-TSXV] lender signaled they’d had enough - and were appointing a receiver less than a year after advancing their loan. On Monday of this week, Ascalade Communications [ACG:TSX] announced that it intends to seek protection from creditors under the Companies’ Creditors Arrangement Act [CCAA] with the British Columbia Supreme Court. “Ascalade’s Board of Directors determined that seeking creditor protection is in the interests of the Company…because of the Company’s inability to fund operations to meet customer demand.” I suppose that’s one way to put it.

At CIBC (NYSE:CM) and BMO (NYSE:BMO), for example, general credit reserves were increased with the announcements of the first quarter financial results. BMO’s CEO Bill Downe indicated that:

Credit quality is typical for this stage of the credit cycle, when we start seeing emerging deterioration in the performance of customer accounts. We have seen an increase in delinquencies which, while still below the industry average, is an early indicator of coming credit losses.

These are straws in the wind, of course, but there’s more. We are starting to hear domestic tales of woe out of the borrower market. Some experienced specialty lenders have issued and signed back term sheets — only to pull them a couple or three weeks later. Before deep due diligence had even begun. The excuses given are part of the same theme: “credit ain’t going to go for it,” or “we just had a corporate offsite and can no longer proceed.”

What was in the water at the corporate offsite. Hemlock?

Basic, straightforward deals; nothing fancy. High quality opportunities. To an outsider there was no obvious reason to bail on the termsheet other than:

  • A dramatic change in the sentiment of the internal credit group.
  • The funding sources are starting to dry up for the specialty finance firms that, themselves, rely on warehouse line lenders or hedge funds to provide a majority of the capital used in their own specialty debt transactions.
  • Problems within existing portfolios are draining the firms of their desire to book new deals.
  • Could it be the U.S. recession? Do lenders want to sit on their hands for a few weeks and see where Citibank (NYSE:C) winds up, now that the Chief Executive of Dubai International Capital has said that:

    It will take more than the combined efforts of the Abu Dhabi Investment Authority, the Kuwait Investment Authority and Saudi investor Prince Alwaleed bin Talal to save the bank. ‘It’s going to take more than that to rescue Citi’. He added that more write downs are expected and that Gulf investors would be required to bolster Citi.

    It was the middle of last year when insolvency law specialist Harvey Chaiton told an audience at the CVCA AGM in Halifax that “things are slow right now, but I expect that to change.” Not many in the audience believed him. If no one (equity or debt) is prepared to step into situations as they go sideways, existing lenders will be forced to act. And those CCAA press releases get noticed by other lenders, which can only but impact the credit groups at many institutions, large and small.

    To paraphrase that wonderful song by Journey from my high school years: Time to start believing.