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US lenders primed for a fall

The collapse of US sub-prime mortgages has caused a crisis
of confidence in the financial markets, sparking sharp falls in equities from
London to Singapore. Central banks have taken the unusual step of pumping
hundreds of billions of dollars into the markets to prevent a liquidity crunch.

Every day brings news of another casualty: Goldman Sachs says it will inject
billions of dollars of its own money to bail out its hedge fund, then the Dutch
bank, NIBC ­ badly hit by its exposure to US sub-prime ­ agrees to be bought by
Kaupthing, the Icelandic investment bank.

This shake-up of the markets could make a finance director wonder whether it
will be harder to get the credit line renewed or find the necessary debt
financing to make the next acquisition. But, while finance directors should
monitor the markets carefully, it is not time to batten down the hatches, say
the experts.

For seasoned market watchers this shake-up of the credit markets has been a
long-time coming and, for many, it represents a welcome return to normality.

Not a surprise

Simon Collins, chief executive of corporate finance at KPMG, says: “I think
we have seen lending conditions that have almost universally been regarded as
insanity. Words like ‘unsustainable’ have been bandied around for some time, yet
everyone reacts with shock at the first sign of a market correction.”

This correction blocked the overnight flow of lending between financial
institutions around the world over several days prompting the Federal Reserve,
the European Central Bank and the Bank of Japan to inject funds into the market.
They took this step to ensure that lending rates stayed close to the levels set
by them.

Central banks, especially the Bank of England, will be relieved if the
current crisis makes investors more wary of risk. When the Bank presented its
most recent quarterly inflation report, the governor, Mervyn King, said that
while he thought the current crisis was not an international financial crisis,
he appreciated the change in credit spreads: “To the extent that these are
starting to widen, I think that’s a welcome development as a more realistic
appraisal of risk is being seen.”

The current credit crunch is affecting those who have used highly
sophisticated financial engineering to slice up their corporate debt into
different tranches that were then parcelled off into complex new financial
instruments such as collateralised debt obligations.

The uncertainty has different implications for different sections of the
market. “My sense is that a financial director at a good quality company with a
clear trading story will find the debt market still open for business,” says

This applies to both a FTSE-100 company planning to make a public bond
offering and a small company wishing to raise around £50m to £200m from three to
four banks. “What is causing the market jitters at the moment is the banks’
concern over their underwriting risk. If investor appetite for billion-dollar
loans has dried up, the banks don’t want to be left holding all of the debt,”
says Collins. As most corporate deals tend to be denominated in millions rather
than billions, banks are likely to be less concerned about their underwriting

Closer scrutiny

But the current edginess means that banks are likely to scrutinise their
client’s financial statements more closely and likely to impose tougher loan
conditions than has been the case in recent years.

Wolseley’s group finance director, Steve Webster, says: “I think if you are a
company that is currently trying to re-finance, or you are not in a strong
position financially, life is likely to be difficult for the next few months.
But if you are in a strong fiscal position, then the current market turmoil is
unlikely to have a major impact. There will, however, be a slight tightening in
credit margins.”

Webster says he will be watching carefully to make sure that this credit
crunch does not spark a crisis of confidence in the equity markets or a slowdown
in consumer confidence. “It is the overall effect this could have on the economy
that would be of greater concern to us,” he says.

Collins thinks that there could be a silver lining for finance directors.
“Private equity is likely to find it harder to raise the necessary debt
financing for its acquisitions so finance directors can worry less about
becoming the next victim of a takeover bid,” he says.

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