Hedge funds target corporate lending as banks dry up

Date: Thursday, October 16, 2008
Author: Karen Brettell, Reuters

NEW YORK (Reuters) - An unprecedented cash crunch is choking the ability of banks to lend and creating an opportunity for hedge funds to launch, or ramp up corporate lending facilities.

Companies that have relied on bank borrowing to grow, or even maintain their business, are turning to hedge funds in a move that some say may signal a broad shift of lending from banks to asset managers.

"I have a very strong belief that the new investment banks will be the absolute return hedge funds and the managers of private equity," said Thomas Priore, Chief Executive at ICP Capital, an investment firm that manages $13 billion in fixed income assets, in New York.

"They're not going to become banks, they're going to provide the functionality and interface with people looking for capital, like the investment banks used to, but with an asset management balance sheet approach," he added.

ICP began lending directly to companies earlier this year, focusing on making loans that are secured against cash flows. Most recently, the company arranged a $121 million financing package for the purchase of two ships that will be leased to a unit of Mexican state-owned oil company Petroleos Mexicanos, or Pemex.

"The capital constraints on banks are opening up opportunities for new entrants, like our firm, who can take leveraged credit assets and loans from bank balance sheets," Priore said. "Banks, and other companies, will not be afforded the leverage they once were," he added.

BANK CONSTRAINTS

Banks have been scrambling for capital to offset losses from bad mortgages and other investments at the same time as both credit and stock investors have been hesitant to back the companies.

The U.S. government has scrambled for ways to shore up the sector, including a plan to pump $250 billion into institutions in exchange for equity stakes. Even when the financial sector does finally stabilize, however, banks ability to lend will remain constrained relative to recent years.

General Motors Corp (GM.N: Quote, Profile, Research, Stock Buzz), First Data Corp, AMR Corp (AMR.N: Quote, Profile, Research, Stock Buzz) and Goodyear Tire & Rubber Co (GT.N: Quote, Profile, Research, Stock Buzz) were among a number of companies that tapped their credit lines last month, as credit markets froze and in some cases on fears that if they waited the capital may no longer be available.

And the more companies that tap their credit lines, the more pressure it puts on bank balance sheet.

"Banks are already balance sheet-constrained and they're getting tapped, so it causes even tighter credit," said Greg Peters, chief U.S. credit strategist at Morgan Stanley in New York.

"What you're seeing also is secondary transactions occur where banks will sell out unfunded revolvers at a discount so they don't have to clog up their balance sheet," Peters said.

Standard & Poor's said on Tuesday than anticipate more high yield companies will need to draw on the credit facilities as long as lending remains strained.

"We expect firms will tap any prearranged credit lines or turn to private capital until conditions improve," analyst Diane Vazza said in a report.

DIRECT LENDING

NIR Group, an alternative investment firm that oversees $7 billion in investments and has been directly lending to small- and mid-sized companies for 10 years, now sees enhanced opportunity to expand the business, said Corey Ribotsky, Managing Member of the firm in Roslyn, New York.

"Alternative investment vehicles are going to replace banks and investment banks as being the only financing source for a lot of companies, small, medium and large," he said. "That field has increased tenfold as traditional investment banks and traditional banks have not been able to lend to these companies at all."

As opportunities increase Ribotsky sees the potential to work with larger companies than it has traditionally lent to, as well as enter into more deals.

"We're seeing an increase in the number of companies looking for capital and the ways in which they're going to be looking for it," he said.

While asset managers look poised to take over much of the business of traditional banks, the way in which lending is done may take different forms.

"To a large degree, I think companies are looking for a business partner," said ICP's Priore.

"Investment banks in the past have really been syndicators of risk, not principal risk takers," he said. "Companies want financing from organizations that have the banking skills but want to participate in their business as a principal as well."