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Businesses Pinched as Loan Spigot Shuts Off

By David Cho and Thomas Heath
Washington Post Staff Writers
Monday, August 20, 2007

U.S. corporations for years operated by the maxim that you have to borrow money to make money. Now, the well of cheap loans is running dry.

The corporate bond market, the MasterCard for U.S. companies, has slowed to levels not seen since the recession of the early 1990s, as rising defaults among mortgage borrowers are causing lenders to question loans going to companies as well.

Without a healthy bond market, a swath of corporate activity is eliminated and the economy slows down. Firms stop borrowing to buy drilling equipment for coal mines, plants for manufacturing cars and land for expanding restaurant chains.

"It affects everything," Michael Tarsala, an analyst for Thomson Squawk Box, said of the bond market. "It's access to capital. It's the lifeblood of a lot of big S&P companies. . . . They've been encouraged to borrow money to make money for so long, and now the spigot's suddenly been shut off."

Shares of Hertz dropped 6 percent last week after concerns that it will struggle to get low-rate loans, the key source of financing for rental-fleet purchases.

Farm-equipment maker Deere & Co. said last week that it is "putting the brakes" on production of construction vehicles.

Mortgage giant Countrywide Financial on Thursday had to tap its entire $11.3 billion emergency funding line after it could not get short-term loans, known as "commercial paper," from the bond markets.

Home Depot is rethinking a plan to borrow money to buy back $22 billion worth of its stock. The turmoil in the debt markets might also scuttle the $10.3 billion sale of its wholesale supply business.

Six years ago, a similar scenario played out when business spending ground to a halt during a recession. Factory floors went idle. The markets dropped about 600 points in August 2001. But consumer spending stayed strong and pulled the economy through.

This time, declining home values are leaving many consumers feeling less wealthy. They might not have enough cash to make up for a loss in business spending.

"Corporate earnings and corporate balance sheets are strong; that's the good news," said John Delaney of CapitalSource, a Chevy Chase lender to medium-size businesses. "What effect the current mortgage market will have on the consumer is the open question."

The summer tends to be a slow time for bonds. But it usually is not this bad: There were fewer corporate bond deals in July than in any month since December 1990, according to Thomson Financial.

The seizure of the corporate bond market might be temporary and is not necessarily a sign of recession. On Friday, the market enjoyed some relief. Several big firms, including Johnson & Johnson and Wal-Mart, announced multibillion-dollar bond deals, jumping on market optimism from the Federal Reserve's surprise decision to cut its lending rate for banks.

Yet some economists worry that a prolonged slowdown in the bond markets would damage company earnings, which have been the lone bright spot in the worsening credit crunch.

"Main Street needs Wall Street. Main Street produces the real stuff in the economy, but ultimately that's financed through Wall Street," said David Rosenberg, Merrill Lynch's chief economist for North America. "The question remains: Who will provide credit to the economy?"

A prolonged credit crunch could also spoil some bond deals in the works. According to Dealogic, a research firm, corporations have withdrawn at least $60 billion worth of bond offerings since late June because no one would fund them at low rates. That figure probably represents just a fraction of the loans pulled off the bond markets but never officially announced, an analyst from the firm said.

Quebecor Media, the Canadian media giant that owns the Toronto Sun and a television station in Montreal, canceled a $750 million debt offering last month after the bond markets started going haywire.

"We were going to the markets. . . . We would get capital at a very, very low cost," said Luc Lavoie, executive vice president at Quebecor Inc., the holding company for Quebecor Media. "We were more in the process of building a war chest more than anything else. We went to the market, and the market was backfiring that very week. It started going up, up, up. We said, the hell with it. We didn't need it."

Some Washington financial companies are also feeling the pinch in the credit markets. Malon Wilkus, chairman and chief executive of Bethesda-based American Capital, said the company sold $338 million, or only about 70 percent, of the $500 million in corporate debt it wanted to place last month.

Wilkus said investors are demanding a higher rate of return on their corporate bonds. "We cleared a little less in this offering than we normally clear," he said. "There definitely was pushback. The market is more demanding."

The problems in the corporate bonds market began when the market for high-yield junk bonds, which are loans given to companies with poor or short financial histories, closed down early in the summer, a spillover from the mortgage mess. As Wall Street's credit problems worsened, panic gripped the markets and other parts of the bond market began to stall.

The market for investment-grade bonds -- or money lent to companies with great credit -- has virtually stopped for the past few weeks. Only companies with credit as good as the U.S. government, such as General Electric, have been able to get low-rate loans from the bond market.

If consumer spending drops, these companies could be hit by a double-whammy -- less money coming in through the cash register and no place to go for low-rate loans.

Several bond traders and company executives said in interviews that there was still a lot of fear in the markets, but that the problems should work themselves out in the fall.

If not, it could be a very harsh winter for corporate America.

"If corporations have to postpone their borrowing, it can have real economic effects," said Michael Decker, head of research at the Securities Industry and Financial Markets Association. "That's new investment that might get canceled, acquisitions that aren't happening, and real economic activity that might not take place."

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