The Financial Accident Just Waiting to Happen

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NE of the great ironies of the efforts by banking regulators at the back end of last year to warn financial institutions of the risks posed by their mounting loan exposure to the telecom industry is that their lending practice was a direct result of public policy.

The UK Treasury bagged a [pound]22.5bn windfall from its auction of next-generation wireless licences, but it effectively pushed the debt burden from the public purse on to the balance sheet of the commercial banks.

Within weeks of these regulatory warnings, the Federal Reserve was openly pleading with the same banks not to cut off liquidity to problem debtors, the bulk of which were telecom companies, as global risk-aversion soared and US confidence slumped. The US central bank backed up its plea with two rate cuts, lowering the cost of funds for banks and giving some ballast to financial-sector interest margins.

Sparking moderate monetary easing in other non-euro zone jurisdictions too, the Fed gave respite to beleaguered securities markets and primary debt-issuance recovered.

In the past three weeks, that tentative recovery has been dealt a series of blows. It started with France Telecom's lousy sale of secondary shares in Orange and culminated in signs that US consumer confidence is deteriorating unexpectedly quickly even as inflation accelerates (due in part to higher energy prices, but also to the falling dollar).

Credit spreads on corporate debt, a great leading indicator for risk appetite, have pushed out yet again to historically wide levels. British Telecom, for instance, now pays a premium three-times greater than the 50-basis points above the London interbank rate that it paid 12 months ago, adding an additional [pound]10m to a [pound]1bn bond programme.

No wonder commercial banks are more cautious on the outlook for 2001. If easier monetary policy and tax cuts fail to fix capital markets in the second half of the year, fresh strains will be exerted on the banking sector as slumping revenues send more debtors into default, forcing lenders to hike loan-loss provisions.

How big is the exposure of the banks to telecom companies? The short answer is that it is unprecedented. Last year, $190bn was lent to investment-grade, high-yield and unrated telecom borrowers, representing around 40% of all syndicated lending facilities to the private sector.

Another $110bn was advanced to the sector in the shape of corporate bonds. Most of the loan facilities were locked in as short-term methods of financing the huge cost of acquiring next-generation mobile phone licences.

The intention for most borrowers was to repay short-term facilities with issues of primary equity and debt and proceeds from the sale of non-core assets. The collapse in demand caused by increasingly risk-averse investors has significantly undermined the attractiveness of these funding channels. The indebtedness of the telecom industry was never a problem as long as there were buyers for its assets.

Yet the asphyxiation of the primary market for telecom equity (at prices that are not prohibitively expensive) has had a domino effect on other asset classes as investors in these markets have also driven up the industry's risk profile. …