How cash-hungry firms could take $700-billion bite out of banks
What if companies across America pull harder on credit lines during this crunch than they did in the last one?
During the depths of the 2008 financial crisis, companies served by U.S. banks bolstered themselves by drawing about 30% of their available credit, with some sectors going much further. If five industries now getting hammered by the coronavirus and oil-price slump were to, say, draw as much as 70%, all corporate clients together would extract a total of about $700 billion from the six biggest banks’ liquidity pools. That’s close to 16% of lenders’ cash-like holdings at the end of last year.
It’s no wonder that the Federal Reserve is already intervening, announcing Tuesday it’s expanding support of markets that usually provide faster and cheaper loans to corporations, easing demand on credit lines and relieving the potential strain on the banking industry. The Fed used a similar move during the last crisis.
Before the Fed’s action this time, dozens of firms in industries most immediately hit by the virus and oil-price war —
such as leisure, transportation, health care, energy and mining — started drawing billions of dollars from existing credit lines this month, negotiated new commitments or sought new loan packages as travel grinds to a halt and nations around the world hunker down. The six big banks have $352 billion of commitments to those sectors alone.
Companies are continuing to lock down liquidity. JetBlue Airways said Wednesday that it used the full $1 billion from an available loan facility, while Boyd Gaming borrowed the remaining $660 million from its revolving credit line.
An industry group for the banks has repeatedly expressed confidence in their capital and liquidity in recent days. Rating company Moody’s Investors Service said in a report Wednesday that liquidity levels at the biggest global banks were sufficient to cope with accelerating cash demands from corporations.
“This does not mean that liquidity cannot be pressured at banks when debt markets are freezing up and recession risk is rising in some of the largest economies,” Moody’s said. “The risk of a sudden peak in drawdowns on revolving credit facilities, if combined with other factors such as lower cash inflows or higher deposit outflows, could weaken banks’ liquidity ratios.”
Analysts have been running similar scenarios of their own. A team at Goldman Sachs Group concluded last week that a 100% drawdown in several embattled sectors would bring seven of the biggest banks to the brink of breaching their regulatory minimums for liquidity ratios.
“If other industries begin to see larger draws, this will put further pressure” on the ratios, the Goldman analysts led by Richard Ramsden wrote in a March 12 report. The analysis excluded Goldman.
To help ensure that doesn’t happen, the Fed announced Tuesday it will bring back a program from the 2008 crisis to help U.S. companies borrow using commercial paper. Investment-grade companies, in particular, rely on that market to meet short-term funding needs. But stress there in recent weeks pushed some to turn to bank credit lines instead. The Fed’s buying program will ease demand to tap those facilities, said Keefe, Bruyette & Woods analyst Brian Kleinhanzl.
“They are direct substitutes,” Kleinhanzl said. “If a company can’t access commercial paper, the revolvers get drawn.”
Still, depending on details of the Fed’s program, it could be easier for some companies to draw on existing lines as the economy worsens.
Surging demand for cash might not strain every bank’s liquidity levels because a loan taken from one might be used to repay another, or the money might simply circle back in the form of deposits, one bank executive said. But if funds from credit lines leave the banking system, then liquidity would decline, the executive said. There’s no reason to expect a flight out of the system because, unlike in 2008, the motivating fear this time is the economy not bank stability, the executive said.
Even as the Fed pumps in liquidity, big banks are constrained by capital ratios against growing their balance sheets to expand lending to companies under duress, Credit Suisse Group analyst Zoltan Pozsar wrote in a note Tuesday. The Fed must start buying commercial paper, he predicted, just hours before the central bank announced it would.
Regulators are considering changes to leverage limits and accounting rules to free up bank capital, according to people familiar with the talks. The Fed on Sunday urged banks to use their excess capital to expand lending. That evening, eight of the nation’s largest banks promised to suspend share buybacks, stockpiling capital for loans.
Holding onto capital will also give the banks a bigger cushion to absorb potential losses if strains in credit markets worsen, the economy shrinks and borrowers miss payments. Overall corporate loan default rates jumped to 4% from 1% during the last crisis. They have been back at 1% in recent years.
By Tuesday afternoon, Congress and the administration were discussing an economic stimulus package of as much as $1.2 trillion that could include loans to some distressed sectors as well as checks to consumers. While such measures could help, similar stimulus packages didn’t prevent surging defaults and bankruptcies in the 2008 crisis as the economy shrank.