Companies Are Maxed Out Too

Jerry Jasinowski doesn't need new problems. As president of the National Association of Manufacturers, he already has a surplus. Industrial production has dropped for 12 consecutive months, the longest stretch since late 1944 and 1945. Manufacturing employment is 1.1 million below its recent peak in July 2000. But now comes an added worry. Meeting recently with chief executives, Jasinowski heard that many companies are struggling to get credit. "This credit crunch is now the No. 1 impediment to recovery," he says. Although that may overstate the case, it identifies an emerging and little-noted problem.

It's the revenge of the "credit cycle." In flush times, lenders relax credit standards. They're eager to lend and exude confidence about repayment. Borrowers brim with optimism. They don't doubt they can repay. Everyone's upbeat. But when economic prospects darken, the process reverses--often with a vengeance. Loan losses obliterate optimism. Lenders tighten credit standards. Borrowers can't get loans or, at any rate, can't get them on terms that seem reasonable and affordable. And sometimes they don't want more, because they're borrowed up to their eyebrows.

The credit cycle applies to both consumer and business lending. But with the cycle now going into its down phase, business lending may suffer most. Consider:

Some problem loans and defaulted bonds reflect optimistic--often reckless--lending in the late 1990s, when the credit cycle was in its euphoric phase. From 1997 to 1999, companies raised $373 billion by issuing "speculative grade" (a.k.a. "junk") bonds, says Diane Vazza of Standard & Poor's. These bonds go to shakier firms, and the volume was almost three times higher than from 1994 to 1996. Even when issued, a quarter of the bonds were rated B-minus or lower--a sign of high risk. (Standard & Poor's has 26 bond ratings; B-minus is 16th from the top.) But the bonds were snapped up by pension funds and other investors. "These were the go-go years," says Vazza. "It was an elevator ride up, and [everyone] wanted to get on."

The ride down has been bumpy. By Vazza's estimate, three quarters of this year's defaults involve bonds issued in 1997, 1998 or 1999. About a fifth of those are in telecommunications (companies like 360networks, Winstar and Teligent). Altogether, their defaulted bonds exceeded $30 billion. But other large defaults involved chemical companies, utilities, paper companies and retailers.

The harder question is how much the credit cycle will depress the economy. The irony is that, just as the Fed is cutting interest rates, both lenders and borrowers are becoming more skittish. This last occurred in the early 1990s, when repeated cuts in rates only belatedly revived business borrowing. From August 1990 until December 1993, banks' C&I loans continually dropped; the full decline was 9 percent. By most accounts, lenders and borrowers were in much worse shape then than now. Banks faced huge losses on real-estate loans. "Leveraged buyouts" and stock buybacks had left many companies with massive debt loads. Early in 1990 companies were paying almost 40 percent of cash flow for interest, says Zandi.

Still, the same logic applies. As the economy and profits weaken, companies have a harder time paying debts. Lenders worry that good loans will turn bad. Tougher credit standards force companies to concentrate on repaying. This prompts cutbacks in jobs and investment, allowing cash to be diverted to debt service.

One of Jasinowski's members is Behlen Mfg Co. of Columbus, Neb. It sells structural steel for construction (office buildings, shopping malls) and livestock pens. Late in 2000 new orders "fell off a cliff," says chief executive Tony Raimondo. The company swung from profit to loss. Its bank instantly put it in a "special workout group." Interest rates were raised, penalties imposed. Behlen restored profitability by laying off 350 of 1,600 workers and cutting new investment. But as yet, the bank hasn't removed the company from its problem-loan list. The company's psychology has changed, and almost everything becomes subordinated to improving the company's credit standing. "You're trying to focus on day-to-day business," says Raimondo, "until the bank gives you the OK."