A year after the collapse of investment bank Lehman Brothers (LEHMQ.PK), frozen credit markets are piecing themselves together again but the face of borrowing is dramatically different.
Lehman's failure trapped money market and hedge fund managers in a web of bankruptcy proceedings, and left derivative deals in limbo along with corporate bondholders.
The fear of further bank failures froze short-term and interbank lending markets, choking credit and blocking the pipeline for the once-massive market in asset-backed securities, also used to supply lending.
The new borrowing environment means the cost of capital for corporations remains higher than in the boom years before the crisis hit, even as official US interest rates have been slashed to near zero.
Tight credit limits companies' ability to spend on new business and weighs on future growth, at a time when US unemployment has jumped to 26-year highs.
In a reflection of how lending has become riskier, Moody's Investors Service downgraded ratings on a record $3.5 trillion of US corporate debt last year on raised concerns about the ability of companies to pay back what they borrow.
For investors, consumers and companies, ranging from conglomerate General Electric (GE.N), which employs 320,000 people worldwide, to Ball Corp, a packaging company with 14,000 workers, the credit landscape offers new challenges.
Corporate officers like Scott Morrison, treasurer of Broomfield, Colorado-based Ball (BLL.N), are having to spend more time securing bank commitment letters and building bank relationships, while banks must diversify their business to limit risk and settle for smaller profits.
A 10-year note issued by Ball Corp in August had 10 banks help with the underwriting, versus five or so in years past, Morrison said.
Borrowers compete with government for finance
Investors shunned corporate debt markets in the panic of late 2008 regardless of individual companies' creditworthiness. The flight to the safety of US government Treasury bills drove yields down to zero or even lower on a few occasions.
As investors lent their money for free to the US government for safekeeping, corporate America struggled to issue new debt or refinance existing bonds.
Yet since December, when investors demanded record high returns to risk buying corporate debt, investors have overcome some of their fears about riskier debt. Issuance has surged to a record volume and fueled a meteoric rally.
Investors in junk bonds also have benefited. Average returns for US junk bonds soared to 40 percent, to lead the performance of major asset classes year to date.
Veteran manager Dan Fuss, of Loomis Sayles, one of the biggest money managers, said the US recession has ended but challenges remain.
"We're not out of this thing yet, but the recovery has started," said Fuss, overlooking the wharf from his Boston harbor office. "The Titanic has stopped sinking."
That said, banks are still struggling to rebuild their balance sheets, investors in corporate bonds remain jittery and many companies cannot borrow as easily as they could in the freewheeling early 2000s. Perhaps they never will.
"Declining U.S. housing prices and securitization remain at the heart of the crisis and problems for the prospects for recovery," said Matthew Tucker, head of US fixed income investment strategy at Barclays Global Investors. "The core problems haven't gone away."
Differentiating between borrowers
Borrowing costs for investment-grade companies are now back down to the lowest levels in four years, partly because safe-haven buying of US Treasuries has pushed benchmark yields down, taking corporate bond yields down as well.
"Spreads have tightened, and this recovery has allowed us to do more market funding without a guarantee," GE Treasurer Kathryn Cassidy told investors recently.
But bigger companies too face a new borrowing environment even as credit markets are recovering. Distrust of financial institutions is still palpable among corporate bond investors.
For instance, when GE Capital Corp sold $2 billion in 10-year notes in August, it had to pay 235 basis points over Treasuries. That's 35 basis points more than a similar deal in 2008 and 120 basis points more than in 2007, according to Thomson Reuters data.
Companies "will pay more until this fear of use of leverage is forgotten," said William Larkin, portfolio manager with Cabot Money Management in Boston.
In absolute terms, GE Capital's interest costs were about 6 percent on 10-year notes it sold on August 4, versus 5.4 percent in February 2007 before the credit crisis began. That difference would equate to $600,000 in additional annual interest expense for every $100 million borrowed.
But for junk-rated companies, borrowing costs on average are over 11 percent, or about four percentage points higher than in mid-2007, before the credit crisis began. That means on average companies would pay an extra $4 million in interest expense a year for every $100 million borrowed.
In leveraged loans, or short-term bank loans typically made to lower-rated borrowers, the weakest companies also have been left out of the recovery.
Moreover, leveraged loan issuance, which was inflated by demand from structured product during the credit boom, is still far below its pre-Lehman levels.
Leveraged loan issuance exceeded $10 billion in 22 of the 24 months ending in December 2007 but has not topped $5 billion in any month since Lehman's collapse, said Morgan Joseph.
That extra borrowing cost is likely to hold back business investment and hiring, especially by smaller companies, and restrain consumer spending in the economy at large.
Markets for complex financial products like CDOs (collateralized debt obligations) and CLOs (collateralized loan obligations), which were at the heart of the crisis, are still stuck in the doldrums and may never revive to past volumes.
JPMorgan Chase & Co (JPM.N) this year closed down its CDO underwriting business. JPMorgan underwrote $20.6 billion of CDOs worldwide in 2006 and a similar amount in 2007, according to industry newsletter Asset-Backed Alert.
That business overall fell to $4.7 billion in 2008 and just $2 billion this year.
Before the credit crisis, the Harley-Davidson Motorcycle company issued one structured finance deal in 2007 and sold all of that security's top-rated debt.
Recently, for a similar deal only 78 percent of the debt found buyers, and it cost the famous motorbike manufacturer about 144 basis points more in borrowing costs to get the deal done.
"Old-fashioned balance sheet lending is back in vogue as well as straight corporate issuances to institutions," said Haag Sherman, managing director of Salient Partners, a Houston-based investment firm. "These will be the predominant forms of lending for some time to come, with securitizations or shadow lending emerging slowly, but steadily."
(Additional reporting by Dena Aubin and John Parry)