NEW YORK, March 19 (LPC) - As corporations draw down on revolving credit lines to combat the expected adverse effects on earnings of the coronavirus pandemic, the ability of US and global banks to provide liquidity has come into question.
The decision to borrow typically undrawn financings has echoes of the 2008 financial crisis when companies drew down on unfunded credit lines, taking the banks by surprise, and putting a significant strain on their deposits.
The virus, which has shut down businesses and borders and left north of nine thousand dead worldwide, according to data compiled by the Johns Hopkins Center for Systems Science and Engineering, is expected to deeply impact the global economy. With this as a backdrop, banks’ abilities to meet funding demands have been questioned.
Lenders’ liquidity and the quality of the assets they are required to hold against the capital they loan are also under scrutiny.
“Beyond the underlying stress that is driving these draws, questions have been raised about banks’ ability to meet the funding demands and the implications for capital ratios and asset quality,” Barclays Capital analysts wrote in a Thursday research report.
After the crisis of 2008, regulators developed new frameworks on capital adequacy, stress testing and market liquidity for banks. Through this global framework, referred to as Basel III, banks have been operating with materially higher capital ratios to withstand the increase in risk-weighted assets related to draws on revolving credit lines. And most corporates borrowing from these credit lines are investment grade — Baa3/BBB and higher — which should limit the immediate impact on asset quality, according to the Barclay’s report.
“Requirements are high, and drawdowns have been steady but not overwhelming,” a senior banker said.
Lenders thus far, are responding well to the requests, though banks with more limited US dollar deposits could face significant challenges if companies start asking for new money in addition to borrowing under their existing loans.
On Thursday, Ford Motor Company said it would draw down US$15.4bn from two of its revolving credit lines and suspend a dividend payment, joining several businesses that are burning cash due to the fast-spreading respiratory virus.
The automaker joins Air Canada, Expedia and Wynn Resorts, among others that have drawn roughly US$22.7bn in bank debt collectively this week, as previously reported by Refinitiv LPC.
Companies are also taking on new bank debt to increase financial flexibility, including JetBlue Airways and American Airlines, which both signed US$1bn, 364-day credit lines this week, according to filings with the US Securities and Exchange Commission.
Companies use revolving credit facilities as backstop financing in case short-term commercial paper lines fail to roll over, and borrowers can draw down, repay, and re-borrow these loans at will. For the most part, these facilities pay low rates and remain undrawn.
“I don’t think this is a bank liquidity issue, I don’t see any bank in trouble, and the (Federal Reserve) Fed has opened up a discount window for the banks,” said a second senior loan banker.
Moody’s Investors Service also said the world’s biggest banks could cope with companies’ need to borrow more cash. But on Wednesday, it warned in a report that lenders are subject to liquidity pressures, particularly at a time when new bond and loan issuance has dropped.
“This is a shock to the system - it’s all happening in two weeks, whereas the recession took more than a year to happen,” said the second senior banker. “If this crisis continues, there could be more exposure.”
There is roughly US$1.2trn worth of untapped revolving credit lines for issuers in the Bloomberg Barclays’ Corporate Index, with approximately US$800bn of this amount concentrated on the BBB rung of the credit spectrum, the Barclays report showed. Sub-investment grade borrowers have about US$500bn in committed revolving credit lines.
If nothing else, as companies’ demand for liquidity grows, banks could start charging more for new commitments to lend.
“Banks can’t charge more on existing credit lines because borrowers will ask for contractual pricing, but if they ask for new money, I do expect the banks to charge more,” the second senior banker said. “I do expect the world to have higher pricing for a while.” (Reporting by Daniela Guzman and Aaron Weinman Editing by Michelle Sierra and Kristen Haunss)