Restructuring

So much ink has already been spilled writing about the looming debt wall that pundits (including the Weil Bankruptcy Blog) are running out of adequate puns to describe the volume of debt maturing in the coming 24 months.  In the first report of a series currently being published, ominously entitled “The Credit Overhang: Is a $46 Trillion Perfect Storm Brewing?,” Standard & Poor’s Ratings Direct analysts take a fresh look at the credit wall that currently may be being built.  In sum, should a number of disruptive factors come together simultaneously, the only question is whether the debt wall we’re looking at will be on Wall Street, or more likely, in Berlin.
Standard & Poor’s’ Ratings Services estimates the total amount of refinancing, capital expenditure and working capital requirements for non-financial corporations over the next five years at between $43 trillion and $46 trillion.  If you want to put that mind-boggling figure into perspective, $1 trillion could pay for a year’s salary for 18 million teachers (there are approximately seven million teachers in the U.S. at last count); Lebron James’s salary for the next 50,000 years; or if you’re into playing the lottery, $6.2 billion a month for life.
In ordinary times, existing financing sources would be able to handle these demands for capital.  S&P, however, sees the following as building blocks for a future debt wall that may be insurmountable:  credit rationing as banks seek to restructure their balance sheets, bond and equity investors re-assessing their risk-return thresholds, the eurozone crisis, a soft U.S. economic recovery following the economic turbulence of previous years, and the prospect of slowing Chinese growth.  The white elephant in the room is, of course, inflation.  Should central banks lose control of inflation, cost of capital will rise, and corporate defaults will flow from already stretched balance sheets.
S&P rightly notes that governments and banking regulators are now not as well placed to counter a perfect storm scenario, given that they already have deployed much of their existing capacity, in the form of fiscal and monetary policy, to deal with the 2009 crisis.  To boot, some countries need to implement austerity measures on multiple levels to deal with their own sovereign debt and budget deficit issues.  And we’ve all seen the problems Greece is facing on that front.
The report puts the burden on getting us through the impending crisis of doom on banking system regulators.  S&P analysts point out that current expansive monetary policy, premised on artificially low interest rates, is likely to produce a fragile recovery with no ability to withstand another large economic shock.  These possible shocks include a backlash in Europe to austerity measures, spiking oil and commodity prices, and a slowdown of growth in China.
Europe, in particular, seems particularly prone to risk: credit rationing is more likely in Europe than in the U.S., where banks are adapting to weaker economies, uncertainty with respect to the sustainability of sovereign debt, more leveraged balance sheets, and tighter regulation in light of the implementation rules for Basel III (which won’t affect U.S. banks for a number of years to come).  Domestic politics will also affect lending: resurgent nationalism (that is, banks being strongly encouraged to lend internally) is also likely to reduce cross-border lending.
U.S. banks, which have only recently migrated to Basel II standards, will also have to contend with lower historical earnings should regulatory reforms effectively remove their ability to continue profitable proprietary trading businesses.
Unsurprisingly, the S&P report notes that, although strong European credits are likely to scale the refinancing wall with the help of their existing bankers, existing borrowers with weak credit are likely to face a tough time refinancing their existing indebtedness.  Borrowers will also have to be vigilant in identifying their actual funding sources.  Corporate loans residing in securitization structures that are unable to roll exposures will cause difficulties for corporations looking to refinance their debt.
S&P estimates that of the $46 trillion in refinancing required for non-financial corporations in the next five years in the U.S., the euro area, the U.K., China, and Japan, $30 trillion will be comfortably met by existing bank lending and access to capital markets.  The balance, some $13-$16 trillion, may not be as easy to come by, and if it comes on-line, will likely come with tighter terms and at a higher cost.
So where does that leave us?  In many respects, U.S. and European economies are largely at the mercy of central banks, who, alone, may hold the keys to economic recovery.  A failure of policy objectives to translate to real world results may end up stacking more blocks onto the respective walls toward which we may be heading.  Pole vaulting classes, anyone?