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Non-Financial Firms Feeling the Brunt of the Subprime Mess (August 15, 2007)

Location: New York
Author: Lenny Broytman
Date: Wednesday, August 15, 2007

The US domestic credit crunch has ripped through virtually everything in its path and according to published reports, the destruction hasn't been limited to just the business world. says that the brunt of the subprime situation has begun to reach non-financial companies, many of whom have suffered as a result of an escalating inability to properly execute their business strategies because of inability to secure credit.

For troubled companies with decreasing stock values, rebounding can oftentimes prove to be an enormous challenge if the particular firm experiencing difficulty has a low credit rating. According to Chris Dinwoodie, head of European corporate ratings at Standard & Poor's, companies with a strong credit history will still be able to stay afloat. even in today's market.

"Companies with high ratings will still be able to do what they have done over the past few years," he says. "The problems will be with the lower credits. There could be some hard times ahead. That said, we've not seen any evidence of this to date."

Simon Mackenzie Smith, head of UK investment banking at Merrill Lynch, agrees, saying: "There's no investment-grade funding crisis as we stand now. But there could be difficulty for lower investment-grade and sub-investment grade companies when it comes to refinancing. The decision will be: do they pay more for their debt, or do they wait?"

Not only does the aforementioned make miniscule acquisitions and organic investment difficult for low credit firms, it also puts a strain on many private equity firms and their attempts to secure financing for various deals. According to industry insiders, this has adverse effects on quoted companies looking to sell of assets. And when it comes to the value of non-financial stocks, many insist that their stock prices could have the potential to be compromised as mounting debts adds to the overall cost of capital. Plainly put.the bigger they are, the harder they fall.

"Many companies in the infrastructure space - such as utilities and transport firms - have been priced off a low cost of capital. These businesses tend to have low but predictable cash flow returns, but their valuations are sensitive to a rising cost of capital and the increased risk associated with funding a high level of debt," says Nigel Sedgley, an analyst at Collins Stewart. "In essence, a lower cost of capital has a disproportionate impact on valuation, explaining why share price performance has been so strong over the past couple of years. But that effect is now reversing."

The ramifications of the credit crisis in the US have gotten out of control, with worries of similar activity spreading into the European and Asian markets. With the European Central Bank pumping an ungodly $194 billion into the European economy in only a week, the world sits on the edge of its seat in anticipation of what will come next.

As is often the case, the worst is over and fear has seemingly taken over as the world's economies scramble to avoid a similar fate. It is evident that the international economy's future rests solely in how well they can manage that fear, without allowing it to become the source of poor decision-making and ineffective risk management in respect to their domestic financial agendas.

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