Higher Borrowing Costs Loom For Caterpillar Finance Unit
06 May 2009 - 7:50AM
Dow Jones News
Caterpillar Inc.'s (CAT) financing arm could soon face higher
borrowing costs that would undermine profits already eroded by
rising loan defaults, debt analysts say.
The U.S. construction equipment maker's April 21 forecast of
sharply lower income and sales for 2009 has prompted credit rating
agency reviews that observers say nudged Caterpillar Financial
Services closer to becoming ineligible to issue low-yield
commercial paper.
"If you get taken out of the commercial paper market your cost
of funds goes higher and your profitability will continue to be
under pressure," said Joel Levington, director of corporate credit
for Hyperion Brookfield Corporate Credit in New York.
Maintaining Caterpillar Financial's liquidity is a critical part
of the company's response to the global slump in construction
spending and equipment demand. Caterpillar, like other equipment
makers, has used its finance company to counter sharply lower sales
and tightening credit conditions for its customers and dealers.
Caterpillar Financial has been able to efficiently raise capital
by selling short-term commercial paper. Without commercial paper,
though, the company would likely resort to issuing longer-term
notes with higher rates.
Wide spreads between Caterpillar Financial's borrowing costs and
the interest charged on its loans made financial products a
reliable profit generator, supplying an average of 15% of the
company's annual operating income for the past five years.
"There's no question that it's been a big supporter of the
earning power of the company for the last few years," said Lawrence
De Maria, an analyst with Sterne, Agee & Leach Inc. "That's
coming to an end."
Illinois-based Caterpillar expects operating income from its
financial products, which include loans and leases, to fall about
40% this year from 2008 as a result of tighter spreads, rising
delinquencies and reduced sales. For the first quarter, revenue
from financial products fell 12% from a year ago, while operating
income dropped 49%. Loans in the company's portfolio that were past
due by 30 days grew to 5.4% in the first quarter from 3.8% at the
end of last year. Bad-debt write-offs more than doubled from a year
ago, to $47 million.
Caterpillar said it continued to use the commercial paper market
during the first quarter and anticipates having sufficient capital
for the rest of the year.
The company, which reported a first-quarter loss on big
restructuring charges, halved its 2009 earnings forecast from
earlier this year to $1.25 per share. It reduced its sales estimate
by about 30% from $51 billion last year.
Standard & Poor's Ratings Service responded by changing its
outlook on Caterpillar and Caterpillar Financial to "negative" from
"stable," but affirmed its ratings. Fitch Ratings, meanwhile,
lowered Caterpillar's long-term corporate rating a notch to "A"
from "A+," but did not change the company's short-term commercial
paper rating.
Moody's Investors Services in January lowered its outlook on the
company to "negative."
Observers say the agencies' moves set the stage for more
significant downgrades later in the year unless the company's
business begins to rebound.
To bolster the agencies' confidence in Caterpillar and hedge
against less access to credit in the months ahead, the company
stockpiled more than $3 billion of cash on its balance sheet in
recent months.
Chief Executive James Owens said last week the cash hoarding is
likely to continue as long as the company's liquidity and credit
ratings remain uncertain.
"There's a lot of pressure on companies to build liquidity." he
said during comments to reporters.
Caterpillar's stock closed Tuesday up 2.42% at $39.41 a
share
-By Bob Tita, Dow Jones Newswires; 312-750-4129;
robert.tita@dowjones.com