Drawdowns of Old Lines May Present a New Issue

Middle-market and corporate borrowers, strained by a weaker economy, are increasingly drawing down funds under terms more favorable than those being offered today.

Some say the drawdowns could force bankers to be as aggressive in paring back exposure to large commercial lines as they were with home equity lines.

Robert Lamy, a banking professor at Wake Forest University in Winston-Salem, N.C., said in an interview Tuesday that bankers were quick to establish credit lines "when nobody needed them" and only now are trying to shut them down.

"The problem is that borrowers are now exercising the option," Prof. Lamy said. "It creates a race to see who can get to the line: the creditor or the borrower."

Christopher Whalen, the managing director at Lord, Whalen LLC's Institutional Risk Analytics, predicted that loss trends will worsen soon.

"Most people who cover corporate lending are predicting record defaults" by early next year, Mr. Whalen said in an interview Monday. Corporate losses could "be sizable," he said, "and I'm not sure there is much that we can really do about it at this point."

The first detectable signs of stress came last quarter, when disruptions in the commercial paper markets led more middle-market and corporate clients to use their lines. The full extent of their utilization may not be known until the Federal Deposit Insurance Corp. releases its third-quarter industry report this month, though several banking companies have provided a glimpse into what occurred.

"We did see an increase in nonperforming loans in that book of business, and we did see some increase — a sizable increase, quite frankly — in criticized" utilized lines, Kenneth D. Lewis, Bank of America Corp.'s chief executive, said last month during a conference call to discuss third-quarter results.

Chargeoffs in the Charlotte company's core commercial business, excluding small-business and commercial real estate loans, more than doubled from a quarter earlier, to 0.28% of total loans, though Mr. Lewis said losses are "still running below our normalized range."

Ralph Babb Jr., the chairman, president, and CEO at Comerica Inc., told analysts on his conference call that rising lines at the end of the third quarter offset a reduction in loan commitments. The commercial portfolio rose 1.3% from a quarter earlier, and utilization rose to more than 51%.

"I attribute that in all likelihood to our larger customer base that was seeing the disruption in the capital markets," he said.

David Zweiner, the chief financial officer at Wachovia Corp., said utilization in the $764.4 billion-asset Charlotte company's corporate book rose 6 percentage points from a quarter earlier, to 32%. That rise was the main reason for a 4.7% increase in the Charlotte company's commercial book, despite efforts to "appropriately reduce unfunded exposures," he said on an earnings call.

It is unclear whether B of A, Comerica, or Wells Fargo & Co., which is buying Wachovia, have definitive plans to shut off the spigot on commercial lines of credit soon. B of A, Wachovia, and Wells would not discuss their plans, and calls to Comerica were not returned.

But those three companies are not alone in citing an increase in corporate credit drawdowns. In a survey the Federal Reserve Board released Monday, nearly two-thirds of senior loan officers reported increases in the dollar amounts drawn under such lines. And about 85% of the officers surveyed said they had tightened standards for originations.

Though overall conditions in corporate lending have abated some since late September, analysts said bankers are far less accommodating now than they were earlier in the year. As of Oct. 31 the spread on a two-year corporate bond was less than half what it was a month earlier, yet it had widened 131 basis points since the beginning of the year, at 5.64%, according to BondsOnline Group Inc. The spread on a five-year bond had widened 218 basis points from January, to 6.84%.

Analysts said that tighter underwriting and higher interest rates will make it harder for large and midsize companies to obtain loans at favorable terms, and that worsening conditions could force more of them to use their credit lines.

Lenders might get an appropriate rate for new originations, but they may not receive "the appropriate award" for credit lines that were created several years ago, Prof. Lamy said. "This is trickier lending," he added.

Most observers agree that de-faults will rise, but some say they are not convinced corporate borrowers are going to create a new combat zone for credit quality, since falling gas prices and improved liquidity from the government's Troubled Asset Relief Program could provide much-needed relief heading into next year.

"Corporate America, excluding the levered transaction subset, has maintained the integrity of its balance sheet fairly well," Jeff K. Davis, a principal at Wolf River Capital LLC, said in an interview Monday. Utilization and losses will go up "significantly" from previous years, but improved liquidity should firm up capital markets. "That should take some of the edge off of loss rates," he said. "So I think that corporate portfolios are going to hang in there and will not be the next shoe to drop."

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