Wary Banks Apply Brakes On Lending To Industry

NEW YORK, Oct. 25 -- The $600-million collapse of Allied Deals Inc. has proved to be the final straw for many lenders to the metals industry in the United States--banks that are now shutting down, scaling back or renegotiating with customers they once courted as attractive business prospects.

When the Piscataway, N.J., trading company went under in May and its principals were arrested on charges of fraud, many said they feared that banks would quit the business, burned by Allied and already reeling from bad loans and lower profits at other clients.

That process, now under way, may jeopardize the future of many small and medium-size metal trading and manufacturing companies, industry sources said.

"Allied Deals has had a major negative impact," said Jim Culver, managing director of the trade finance division of Canada's Maple Financial Group. "It's scared a lot of lenders out of the business." The biggest casualty among banks so far is Hypovereinsbank, which lost $51 million when Allied Deals collapsed. In late September, the company pulled the plug on its commodities lending business, which had been based in New York.

Pittsburgh-based PNC Bank lost $45.6 million and is scaling back lending in the sector. Even J.P. Morgan Chase, which managed to limit its losses to $2.7 million, is anxiously renegotiating terms with clients in the metals business.

One PNC commodity customer said his bank had clamped down on the terms of his credit line, increasing the level of collateralization required even for hedged material and threatening to increase charges for new credit lines or extensions to the existing line.

Meanwhile, another trader said that Chase wanted to rip up their existing agreement and replace it with one clearly more in its favor, charging new fees where none existed before. He said it was not just Chase that had lost interest. "Citibank approached me. We talked, then they discovered it was metal and they weren't so keen."

Another veteran trader said, "The whole industry has been tainted, and rightfully so. No bank is going to do business with us."

AMM approached a range of banks but most refused to comment. Chase, whose share price has collapsed by more than 50 percent this year, would not answer specific questions about its conduct, but instead congratulated itself on a "tremendous performance of which we can all be proud."

John Deere Credit, which lost $43 million to Allied Deals, referred all inquiries to its chief counsel, Timothy Haight, who declined to comment.

A PNC executive admitted reducing business in the sector but would not comment further.

That banks are now turning their back on the metals industry should surprise no one. For Robert Schulten, vice president, metals and pulp and paper, at General Electric Capital Corp.'s Commercial Finance division, the taint of Allied Deals was "one more chapter in a big book. This wasn't the starting gun." Others agreed with that assessment. "Allied Deals put another nail in the coffin, but banks have been withdrawing for a while now," said Sohail Hasan, managing director of IIG Capital LLC, a company that arranges financing for the industry.

Credit ratings in the industry have been sliding for years due to the bite of low commodity prices and low demand. Phoenix-based Phelps Dodge Corp., for example, has a Standard & Poor's credit rating of BBB-minus compared with A in 1993. Even mighty Alcoa Inc., Pittsburgh, has slipped to A from the A-plus rating it held in 1992.

Meanwhile, the steel industry has seen 35 companies file for Chapter 11 bankruptcy protection in the past five years, among them such giants as Bethlehem Steel Corp., Northwestern Steel & Wire Co., LTV Corp. (since liquidated), Trico Steel Co. (subsequently purchased by Nucor Corp.), Wheeling-Pittsburgh Steel Corp. and, most recently, National Steel Corp., Mishawaka, Ind., which fell victim earlier this year.

Nonferrous metals producers also have seen their share of financial pain. Horsehead Industries Inc., the largest supplier of zinc in the United States, filed for Chapter 11 in August; Doe Run Co., St. Louis, North America's largest integrated lead producer and the world's largest primary lead producer, has struggled to restructure its debt burden; and Asarco Inc., Phoenix-a unit of Group Mexico SA de CV and one of North America's oldest copper producers-is beset by debt, sluggish market conditions and soaring environmental costs, and is fighting for its survival.

Add to this the rake of corporate scandals in metal and out-Enron, Global Crossing, Tyco and WorldCom, to name but a few-along with the collapse in equity prices and the billions of dollars lost in bad loans to the technology and telecommunications sectors, and you've got a real problem, according to analysts.

Another factor is a proposal for new capital adequacy provisions coordinated by the Bank for International Settlements in Basel, Switzerland, Hasan said. The net effect is that it is no longer in banks' interests to lend as much to companies that produce or trade metal products.

"Banks have pulled back," said Culver, whose company remains in the trade finance business. "The world is riskier; banks are tightening their credit standards." There's no longer so much money to lend out and consequently banks were focusing on more high-margin, low-risk clients.

"The wave of consolidation in the banking industry and tightening credit standards during a very difficult macro-environment is restricting access to financing for many companies," said Tom Watters, an analyst at Standard & Poor's.

This could spell disaster for the metals sector. It's not just large producers that struggle to raise finance to fund capital spending. Traders, stockholders and fabricators will all feel the pinch as their access to credit lines decline.

"Banks are moving to what they consider is their comfort zone," said Cristina Roberts, managing director of the Global Commodities Group at Fortis Capital Corp. "Some don't want to deal with smaller companies. Others who've been burned lending to bigger companies against their balance sheets will now only deal with smaller companies."

Craig Bonnell, vice president of Profit Guard, a company that assesses credit risk for its clients in the metals business, said that companies with revenue less than $50 million would find it increasingly difficult to borrow. "Commercial lenders don't see it as profitable lending; they will want bigger fees," he said. "I do see companies going out of business."

Increasingly, big banks would be interested only in big deals, most likely in oil, natural gas and pipeline construction, with each transaction worth hundreds of millions of dollars, Hasan said.

This is in marked contrast to the way the business evolved. Traditionally, commodities financing was dominated by European banks, often old merchant banks that initially specialized in this kind of business before expanding to other areas. The banks grew big by extending trading companies' credit lines-either unsecured or based on accounts receivable or inventory. For instance, if a trader had arranged to sell 20 tonnes of aluminum to a customer, he would be able to draw down money from the line based on a certain percentage of the receivable.

Hypovereinsbank was a key writer of this type of business, and its departure from the market will be felt acutely, not least because it catered to smaller and medium-sized borrowers.

"Some banks only got involved with the highest-quality companies, others did middle-ranking companies," Culver said. "Hypovereinsbank did a lot of business with smaller players. It did good business."

Small metals companies, be they traders, component makers supplying the likes of General Motors Corp. or midsize metal stampers, now will have to approach other lenders who may only be interested in customers who need large credit lines or those who focus on niche business that tends to be more profitable. But there are fewer companies offering this kind of service, and the type of finance they have on offer will likely be more expensive.

"They don't need business of that size," one trader said. "You push so far, but pushing is as far as you can go."

Still, not all lenders have left the market-particularly those that offer asset-based rather than cash-flow-based or unsecured finance.

Leading the field in providing finance to the metals sector is GE Commercial Finance , which currently has some $1.5 billion worth of loans on its books and expects this tally to rise to $2 billion by the end of the year. That puts it in the No. 1 spot ahead of J.P. Chase and PNC.

The company originally moved into the credit business during the Great Depression of the 1930s to enable people to more easily afford its home appliances.

Demand for GE's services has grown steadily in the two years that it has been lending to the metals industry. Its increased business undoubtedly coincided with many companies sliding down the ratings ladder just as banks were tightening their credit, but this was a key reason for the company's success, according to GE's Schulten.

"If the assets are there, we lend the money," he said. "Where the company or the market are going is a secondary consideration."

Companies that come to GE do not have to rely on their balance sheet to secure finance. Neither do they have to renegotiate loans if their ratings slip, Schulten said.

So far, the bulk of GE's business has been with customers in the steel sector and with manufacturers, although it has financed traders and nonferrous businesses, too. Business with trading houses remains more difficult, because often their assets are outside the United States and that makes it hard to obtain the liens necessary before the money can be released, Schulten said.

Meanwhile, Fortis Capital said it was still lending to all sectors of the market and was "actively looking to grow" its metals portfolio. The company bought Dutch bank MeesPierson in 1997 and with it acquired a substantial commodities finance business. Like competitors, much of the bank's lending is secured against assets, according to Roberts, but the bank still does a number of unsecured transactions, depending on a customer's balance sheet.

However, Fortis was not interested in financing the occasional shipment of a commodity but would rather finance a regular flow of goods for its clients, according to Roberts "We like to see a certain level of critical mass. It takes a lot of work to get to know a company," she said.

And while GE can extend credit lines as low as $10 million, average credit extended to customers is in the region of $30 million to $40 million.

This is still too big for many trading companies, according to IIC Capital's Hasan. Around one third of the metals sector has a turnover ranging from $2 million to $30 million and their business would not be attractive to most lenders, even GE, he said.

Banks had too many overheads to finance $5-million deals, he said. Small trading operations may be tempted to turn to the likes of Glencore or rich investors, sometimes ex-traders themselves, to help them finance individual deals, but this can be expensive and restrictive.

IIC, though, is able to offer asset-backed finance for smaller deals and believes it can continue to grow in this sector of the market. The company was founded five years ago and already has some $140 million pledged from investors that it is able to lend to clients.

Asset-backed finance can still work out to be more expensive for metal companies than traditional commodity financing, though, according to the experts. Lenders also face the risk that assets their clients say are there in fact do not exist, as allegedly happened with Allied Deals.

IIC said it physically checks that the metal exists. GE also said it had expert auditors who go out and perform spot checks. Both companies said Allied Deals approached it for finance, and unlike many banks that got caught up in the scandal they refused the business.

GE did get caught out at McCook Metals LLC, though, where it alleges the owners of the Chicago-based rolling mill fraudulently misrepresented the size of inventory to gain access to millions of dollars it would otherwise have been refused. GE eventually got its money back, but was forced to spend time and money pursuing the matter through the courts.

"Fraud happens occasionally. It wasn't pleasant, but I don't think we lost money," a GE spokesman said. Still, the shadows of McCook and Allied Deals and the taint of too many bankruptcies will continue to drive banks out of the sector.

And although ProfitGuard says it has noticed some lending resume in the steel sector, where Section 201 safeguard measures have boosted prices and demand, others expect metal companies will continue to face difficulties.

"Next year will be very challenging," S&P's Watters said. "Very weak companies may be bought out, file for bankruptcy or liquidate."

Fewer banks will offer fewer services to fewer customers, observers said. Those borrowing likely will be larger entities, and those whom asset-backed lenders are able to trust.

But it wouldn't be the first time that banks have cold-shouldered a sector, analysts said. And the bankers who were lazy enough not to check Allied Deals' credentials properly, and then were short-sighted enough to quit the sector, will likely be back when better times return.

"In the 1990s you saw lenders fighting for deals. Then hard times came and now deals are starting to unwind," Bonnell said. "When balance sheets are strong again, you'll see lenders fighting each other for business.

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September 2018:

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