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Signs point to tight business lending in 2010

by: MATTHEW BRISTOW Tulsa World Business Viewpoint
Thursday, October 15, 2009

October is when many companies are preparing budgets and business plans for the following year, so it seems a good time to consider the credit environment for 2010.

While there is no crystal ball, we do have 100 years of historical data from the Federal Reserve to give us clues to business lending levels and business failures coming out of a recession. The good news is that there are some clear patterns that have occurred after every recession.

To apply historical data to the future, we need to know when this recession ended, and industrial production has proved to be a consistent marker. More accurately, a reduction in year-over-year declines in industrial production defines the end of a recession. So, unless there is a “double dip” in the coming months, the recession likely ended in July.

Before we consider future business lending levels, we need to understand the current business lending landscape. In the last 30 years, even at the fastest pace of growth, it has typically taken 10 or more years to double commercial and industrial lending levels. However, it took less than half that time for C&I lending to double from May 2004 to a peak in November 2008, according to the Federal Reserve Bank of St. Louis.

C&I lending has been declining since December, and history suggests it will continue to decline — year-over-year — for up to three years after the end of this recession.

And not only is business lending declining, but the pace of the decline is increasing. Typically, the pace of declines has increased for up to 18 months after the end of a recession, so it is likely that this time we are going to break the 1949 record of a 9.3 percent year-over-year decline.

If C&I lending follows the historical pattern, lending levels could drop from $1.64 trillion in October 2008 to less than $1.3 trillion at some time in 2011. Assuming no change in supply and demand for loans, that would be a shortfall of approximately $350 billion.

The demand for new and replacement debt will likely increase in the next two years. Many stronger companies that previously carried little or no debt will start to take on new debt. Banks are competing for this business.

This will be combined with medium- and higher-risk business loans that were made to what appeared to be strong companies at competitive rates a year or so ago, when less stringent credit was available. At a minimum, these weaker companies are going to need to renew or replace their existing debt and there are not as many banks competing for this business.

The supply of new and replacement debt will likely fall over the next two years. As a result, there will be a widening gap between supply and demand, and it will be the weaker companies that will suffer when they are unexpectedly unable to replace or renew their debt.

This could trigger three things: a) Lenders will increase interest rates and fees to compensate for the additional risk of these medium to high risk loans, thus putting further pressure on companies’ already weak balance sheets; b) some businesses will have to switch to more costly forms of debt; or c) a shortfall in supply will lead to an increase in defaults on C&I loans, which leads us to review historical business failures after a recession.

According to the American Bankruptcy Institute, U.S. Business bankruptcy filings have now risen every quarter for 13 straight quarters since the bankruptcy rules changed in 2005. To compound this trend, business bankruptcy filings have kept increasing for between two years to five years after the end of each previous recession.

Our intention is not to spread doom and gloom, but to raise awareness that the economic battle is not yet over. As a CEO or CFO, you may want to consider professional advice, assistance or even a confidential sounding board to renew, raise or replace debt next year.

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Matthew Bristow is managing director of ClearRidge, LLC in Tulsa.

The views expressed here are those of the author and not necessarily the Tulsa World. To inquire about writing a Business Viewpoint column, e-mail a short outline of the article to Business Editor John Stancavage at john.stancavage@tulsaworld.com.