THE ECONOMICS OF THE PRIVATE MARKET
Effects on and Alternatives of Borrowers
The effect of this credit crunch on the economic activity of potential borrowers is impossible to assess with any precision. As private placements are seldom the vehicle for providing day-to-day working capital, it seems unlikely that many potential borrowers have failed because of a lack of financing. Private placements often provide funds for expansion, however, and the growth of some medium-sized businesses possibly has been constrained by this credit crunch. According to market participants, one rationale for private issuance is not only to lengthen the maturity of their debt but also to loosen constraints imposed by the collateral requirements typical of bank loans. Many medium-sized borrowers can obtain bank loans only in amounts up to 50 percent of finished inventory and 80 percent of eligible receivables. Often, upon reaching those limits, borrowers have issued an unsecured private placement, used part of the proceeds to pay down the bank debt, and used the remaining proceeds and new bank debt to finance expansion.
With that course no longer open, low-rated borrowers must attempt to find other sources of capital. The bank loan market seems to be the first alternative for many lower-rated borrowers. Although market participants disagree somewhat, most report that the credit problems at commercial banks have caused these banks to limit lending, to tighten terms as lines have come up for renewal, or even to eliminate lines of credit. This view is confirmed by the surveys of the lending terms of large banks periodically undertaken by the Federal Reserve System. 155 Furthermore, some insurance companies have reportedly had to increase their loans to existing borrowers whose credit lines have been cut by their commercial banks. 156
Some low-rated companies have taken advantage of favorable stock market conditions in 1991 and 1992 and issued equity. In some cases, the reduced leverage resulting from equity injections has raised issuers' credit ratings to investment grade, and has given them renewed access to the private bond market. Alternatively, some firms have attached credit enhancements to their private placements to move up to an investment-grade rating. The public junk bond market, despite its revival in the latter half of 1991, has been a source of funds for only a few companies, as the typical below-investment-grade private issue is generally too small and too complex a credit for the public market.