Borrowers Find There’s Always Someone to Lend Another Buck
By KATE BERRY
At every level of society there are financial desperation cases,companies, governments and individuals that are swimming in debt and must borrow quickly at whatever interest rate the market will bear.
Topping the borrower pecking order is the state of California, a behemoth debtor with a $38 billion deficit.
Yet, the fifth-largest economy in the world has a lot in common with the average Joe paying a minimum balance on a credit card every month.
Neither has a shortage of lenders.
From banks to bond funds, credit card companies to pawnshops, lenders are fighting in a crowded environment to capture the riskiest borrowers.
While there is no way to tally how much money has been farmed out by distressed lenders, U.S. consumer debt continues to balloon above $2 trillion.
The average U.S. household carried more than $11,000 in credit card debt each month last year, according to Web site Cardweb.com.
In recent years, it hasn’t been hard to find borrowers in trouble. They’re everywhere.
In the late 1990s, businesses with unlimited growth plans gorged on the biggest debt buildup in corporate history, resulting later in some of the biggest bankruptcies ever seen. Caught up in the same swell were individuals who borrowed against stock and other assets and ended up setting records for personal bankruptcy filings last year.
With those wounds still raw, now it’s the turn of governments. Factoring those same optimistic projections into tax revenue estimates, they’ve run up deficits that will be hard to unwind.
California may be the worst, but it’s not the only state with a problem; at the federal level, the projections are for the largest budget deficit in history.
Bad as it sounds, nearly everyone still has borrowing options.
For people who have no credit but something that can be sold, a pawnbroker acts as a local bank. Pawnshops will lend 10% to 25% of the value of a piece of jewelry, for example, which is kept as collateral. Surprisingly, a majority of pawnshop patrons eventually get their goods out of hock.
Passing Plastic
But for a society that loves to shop, plastic obviously is the borrowing vehicle of choice.
Credit cards are the most widely available form of debt. For some small businesses, they are simply a way to finance payroll or business expenses.
Yet credit cards are decidedly democratic. They charge exorbitant interest rates, hefty finance charges and stiff late-fee penalties to nearly all borrowers who keep a balance month-to-month.
Higher up the credit food chain are traditional banks.
When the technology and telecom bubble burst in 1998, banks backed out of cash flow lending. Only slowly have they crept back into the market, lenders say.
Taking their place are cash flow and asset-based lenders, such as GE Capital or Foothill Capital Corp. in Santa Monica, a unit of Wells Fargo & Co., which provide specialty financing by lending against inventory or cash flow.
But the hottest and most competitive lending arena now comes from private equity firms, such as Cerberus Capital Management or the Back Bay Capital division of FleetBoston Financial Corp., which work with a company in dire financial straits by providing a full package of financing options.
This form of financing, often called Term B or “last out,” is subordinated only to bank debt. Lenders offer anywhere from $10 million to $40 million in senior subordinated loans to troubled companies. They also often take an active role in management.
Often transitional lenders structure a deal by taking a piece of the equity or warrants in a company. In a worst-case scenario, they may take over the company entirely or appoint themselves to the boards to gain control.
“There’s a reason they call them lenders of last resort,” said Matt Niemann, director at Houlihan Lokey Howard & Zukin, a Los Angeles investment bank. “Their motive is to get the highest return possible.”
Many of these lenders also might buy the distressed bank debt of the company at a discount. This gives the transitional lender leverage to take over the company, if need be, meanwhile earning returns of up to 25% or more if the borrower’s turnaround plan is successful.
“These things are usually structured to call a borrower’s bluff,” said Niemann. “But if the borrower doesn’t prove their story and meet the threshold, the lender will consume the equity and dilute existing equity holders.”
California, of course, has become notorious in recent months as the biggest desperation debtor around. Its $38 billion shortfall,tentatively winnowed by officials in Sacramento in a deal that faces a court challenge,helped spur a citizens’ revolt that culminated in the recall of Gov. Gray Davis in October.
Taxpayers Brace
But what separates California from other desperate borrowers is its ability to pass costs downstream to taxpayers, who are bracing for the costs.
“We’re talking billions of dollars that goes toward servicing those bonds that will fall directly on the backs of taxpayers,” said Bill O’Connor, managing director of the Western division at O’Connor Southwest Securities, a Los Angeles municipal bond firm.
Berry is a staff reporter with the Los Angeles Business Journal.
