During the last five years, businesses in America have experienced an explosion in the availability of capital for corporate and real estate debt and equity financing and investment. As non-traditional lenders have amassed capital for investment in corporate and commercial real estate debt instruments, and as clever lawyers and investment bankers have created ever-more complex methods for packaging pools of debt and spreading risk, competition in the lending marketplace has driven pricing to record lows and led many borrowers to assume that debt would be forever refinanced. Numerous factors have combined to teach us that those days are over.
The bursting of the subprime residential mortgage finance bubble was merely the triggering event in a long cause-and-effect chain that has now dramatically reduced financing available to even high-quality commercial borrowers. Money center banks have been forced to take billions of dollars of off-balance sheet debt onto their books, impairing their capital bases. As less money has become available to buy debt, investment banks have been forced to swallow billions of dollars of loans and bonds in committed LBO transactions that can no longer be syndicated. Hedge funds and non-bank lenders have been forced to mark illiquid assets to some hypothetical market value and report vast losses; investors in these funds have withdrawn capital as fast as they are permitted. Community and regional banks have suffered their first losses in years due to failed construction and commercial real estate loans. One observer anticipates that the next few years will see as many bank failures as occurred during the savings and loan crisis of the 1980s.1
These events, and the fear that they have engendered in the credit markets, have led even high-quality borrowers in all business sectors to experience a constriction in available credit. Funding for what has traditionally been perceived as garden-variety corporate and real estate finance, whether asset-based, project, cash flow or commercial mortgage, is much more difficult to find and negotiate than even a few months ago. Perfectly sound borrowers with excellent credit histories and solid business prospects are defaulting on debt at maturity for no reason other than their inability to locate funds for refinancing or their failure to anticipate lenders' requirements for increased equity capital and tightened transaction structures.
Commercial borrowers would be wise to consider this phenomenon long before it becomes a problem. In today's market, it is not too early to begin to seek refinancing of maturing debt a year or more in advance. Commercial borrowers may also want to consider redundant loan commitments in order to avoid the risk of a lender's failure to close. Large facilities that are likely to be syndicated should require more carefully negotiated underwriting agreements.
Footnote
1. Reuters interview with Gerard Cassidy of RBC Capital Markets, January 31, 2008, reported at http://www.reuters.com/article/email/idUSN0143367820080201 (visited February 24, 2008).
Duane Morris is experienced in anticipating and addressing issues arising in today's difficult credit markets (often in these circumstances, the earlier steps are taken, the more quickly issues can be brought to resolution). Our Credit Crisis and Subprime Lending Group is an interdisciplinary task force of lawyers from our Corporate, Real Estate, Trial, and Business Reorganization and Financial Restructuring practice groups. Our breadth of representation has allowed us to introduce clients with investment capital to other clients with capital needs.
If you have any questions about this Alert or would like more information, please contact any member of the firm's Credit Crisis and Subprime Lending Group.
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