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December 21, 2000

Credit Crunch Starts Hurting Big Firms
By Paul M. Sherer And Gregory Zuckerman, The Wall Street Journal

Credit Lines in Critical Condition ... Weiss comments

NEW YORK - After squeezing the junk-bond market and driving up borrowing costs for investment-grade companies, tightening credit conditions in U.S. financial markets are gripping the edges of the $1.6 trillion commercial-paper market, the biggest source of short-term funding for blue-chip U.S. corporations.

Top-rated borrowers including AT&T; Corp., Lucent Technologies Inc. and DaimlerChrysler AG all have seen their short-term borrowing costs climb during the past two months after credit-ratings agencies put the companies' ratings on watch for possible downgrades.

Meanwhile, dealers expect some second-tier borrowers will be forced to tap back-up bank credit lines in coming weeks after failing to resell commercial paper coming due around year end to new or existing investors, a process known as "rolling over." The cost of tapping the commercial-paper market has soared for such borrowers. The interest-rate differential between borrowers with second-tier ratings and top-tier ratings was about 0.25 of a percentage point for much of the year, but soared to 1.21 percentage points by last Friday.

Commercial paper -- promissory notes to repay money -- is the lifeblood of big companies. Corporations with strong credit ratings issue it to borrow funds for anywhere between one and 270 days. Commercial paper is bought by money-market funds, insurance companies and any firm needing to park extra cash.

For much of this year, rising worries about the health of U.S. corporations have weighed on parts of the bond market. Climbing defaults, record debt levels, a slowing economy and lower profits have made bond investors nervous, especially those investing in lower-rated junk -- or "high yield" -- bonds. Until recently, commercial paper was insulated, expanding 22% during the year ending in September.

Now, any company that isn't rated at the very top tier of the market has to pay up to get investors to buy its commercial paper, and some long-time issuers suddenly are finding it hard to obtain financing in this critical market.

As the economy slows, investors' "tolerance for risk is not that high," says Jack Cunningham, head of the commercial-paper business at Lehman Brothers Holdings Inc. During 2001, "the market may be less generous."

Between weakening corporate health and rising caution by banks, some big-name companies are having a harder time arranging backup credit lines for commercial paper. Credit-ratings agencies require companies to maintain these lines, which are pegged to a floating interest rate such as the London interbank offered rate, or Libor, in case the commercial-paper market dries up. But bankers are loath to see these used: Not only do such credit lines yield thin profits, but banks also see a higher risk that they might get drawn upon, tying up their capital.

Corporate credit quality in general has been declining rapidly, according to the ratings agencies. Downgrades of short-term credit ratings for commercial paper have outnumbered upgrades by 5-1 so far during the fourth quarter, compared with about 2-1 during the first three quarters of the year, according to Moody's Investors Service.

The "risk premium" that investors demand for holding even blue-chip corporate bonds has risen sharply. The bonds in the S&P; Investment Grade Index are yielding 2.49 percentage points more than Treasurys, compared with a 1.37 percentage-point spread in January, says Diane Vazza, head of global fixed-income research at Standard & Poor's Corp.

Just recently, we told you how big investment banks like JP Morgan, Chase, and Bank of America are feeling the pain of bad loans as many corporations find it difficult to pay back what they owe in the slowing economic environment. We also told you that corporate borrowing -- and investment and expansion -- would eventually dry up across the board.

As predicted, the credit crunch has spread like a virus. It started out infecting small businesses and risky start-ups that borrow from banks or issue high-yield junk bonds, then quickly contaminated blue-chip companies that depend on funding from the commercial paper market. Companies who issue commercial paper generally have their commercial paper treated like gold. Nowadays, though, some companies' commercial paper isn't worth, well, the paper it's printed on.

That isn't good news for the U.S. economy. Businesses who can't borrow can't expand. More importantly, those who depend on credit lines to pay their bills will have to lay off workers and cut costs by other means. In the worst cases, companies will go out of business altogether.

A credit crunch is exactly what burst the Japanese economic bubble and plunged it into the depression that it is still experiencing today. The danger to America's economy isn't as bad as the one that engulfed Japan, but it could become much worse if politicians ignore the fundamental problems in our economy -- accelerating inflation, a staggering trade deficit, and a contraction of credit.

As the credit crunch runs its course, we won't be surprised to see the U.S. enter a full-blown recession in the New Year. Only time will tell if a depression is on the horizon.

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