Sector Spotlight: Banks Wince at Looming Telecom Debt Worries

Trouble ahead ... trouble behind....

Banks could well be singing those familiar Grateful Dead lyrics when they take stock of their telecom debt nowadays. Soaring spending and tumbling stock prices have many telcos humming the blues as access to capital markets grows scarce. And banks already struggling with problem loans could soon be facing even more losses from the troubled sector.

"It's a massively troubled industry," says Nancy Bush, analyst at Ryan Beck. "Of course, everyone is buzzing about Lucent (LU Quote - Cramer on LU - Stock Picks)," she says, referring to the telecom-equipment provider's high-profile woes.

Upstarts like Winstar (WCII Quote - Cramer on WCII - Stock Picks) and Teligent (TGNT Quote - Cramer on TGNT - Stock Picks) could also become headaches for their lenders. The companies have borrowed aggressively to build infrastructure and networks, but their considerable leverage is a growing problem in a slowing economy.

Among the lengthy list of problems at Lucent are hefty losses, an investigation into its accounting practices, debt downgrades that left the company's credit a notch above junk status and five consecutive quarters of disappointing financial results. "There are so many moving parts to consider with regard to Lucent's situation it's difficult to single out the most pressing issue," Gimme Credit analyst Carol Levenson wrote Thursday in her daily newsletter.

Facing tough conditions and wary lenders, Lucent managed to pull off a $6.5 billion financing deal last week but had to agree to strict financial and operating agreements in return. For instance, the company's net worth can't dip below $23 billion, writes Levenson in her research, noting that's not much lower than the year-end figure of $26 billion. "As for the new bank agreements, we doubt any investment-grade company has ever promised to live within so many financial and operating constraints."

Once Bitten

But the risk is a two-way street for banks and lenders. Despite the fact that banks have already been burned by some high-profile loan losses, and the writing on the telecom wall is clear, saying no to a large client can be hard, particularly when it means missing out on the kind of lucrative fees that subsequent underwriting deals often yield.

Bank Lending Dials Up Telecom Disconnect
Trouble Ahead?
Company	Loan Commitment/ Lenders	Stock Price-12 Months	History
Lucent (LU: NYSE)	$6.5 Billion /Feb. 2001 J.P. Morgan Chase (JPM: NYSE), Citigroup (C: NYSE), Bank One (ONE: NYSE), Bank of America (BAC: NYSE), FleetBoston (FBF: NYSE), Mellon (MEL: NYSE), Northern Trust (NTRS: Nasdaq), State Street (STT: NYSE)	-80%	Has had a string of earnings disappointments; debt downgraded near junk; is being investigated for accounting practices. Company agreed to strict requirements in exchange for current loan.
Teligent (TGNT: Nasdaq)	$800 Million Senior Secured Credit/July 1998 Goldman Sachs (GS: NYSE), J.P. Morgan, Bank of America, UnionBanCal (UB: NYSE), Barclays (BCS: NYSE ADR)	-98.2%	Fourth-quarter EBITDA widened to loss of $119M from $110M. Costs nearly doubled. Seeking additional funding.
Winstar (WCII: Nasdaq)	$1 Billion/April 2000 Bank of New York (BK: NYSE), Citigroup, Barclays, FleetBoston, J.P. Morgan	-75.9%	Fourth-quarter EBITDA loss narrowed to $19.9M from $61.8M. Company lost $1B last year on sales of $759M.
XO Communications (formerly NextLink) (XOXO: Nasdaq)	$1 Billion/Feb. 2000 Goldman Sachs Credit Partners, Barclays, J.P. Morgan Chase, Bank of America, Fleet Boston, PNC Bank (PNC: NYSE), Bank of New York	-74.5%	Fourth-quarter EBIDTA loss widened to $88M from $59M. Company cut first-half revenue estimate by 10%.
Trouble Behind
Company	Loan Commitment/ Lenders	Stock Price-12 Months	History
ICG Communication (ICGXQ: Nasdaq)	$200 Million/July 1999 Royal Bank of Canada (RY: NYSE), Morgan Stanley (MWD: NYSE), Bank of America, Barclays.	n/a	Filed for Chapter 11 in November. Stock delisted.
NorthPoint Communications (NPNTQ: OTC BB)	$250 Million/May 2000 Goldman Sachs Credit Partners, First Union, FleetBoston, PNC Bank, UnionBanCal.	n/a	Filed for Chapter 11 in January. Stock delisted.
Globalstar (GSTRF: Nasdaq)	$500 Million Credit/August 1999 Arranged by Bank of America. Loral bought the facility in November.	-97.9%	Shareholders have filed a class-action lawsuit against Loral (LOR: NYSE) CEO Bernard Schwartz.
Source: Bank Loan Report, TSC Research. Note: Data reflect original loan activity. Loan exposure may have changed due to repayments, sales or securtizations.

Indeed, The Wall Street Journal reported this week that as heavyweight lender J.P. Morgan Chase (JPM Quote - Cramer on JPM - Stock Picks) ponied up $942.5 million for the Lucent deal, Goldman Sachs (GS Quote - Cramer on GS - Stock Picks) and Credit Suisse First Boston were removed from Lucent's upcoming IPO deal after they declined to participate in the loan.

Aside from this, Goldman has been fairly active in telecom lending, taking lead roles in syndicated loans to companies including Teligent and XO Communications (XOXO Quote - Cramer on XOXO - Stock Picks) (formerly NextLink). But perhaps some of its telecom investments have made the bank gun-shy on loans, including a $250 million credit arranged for NorthPoint Communications (NPNTQ Quote - Cramer on NPNTQ - Stock Picks), which filed for bankruptcy and was delisted in early February. Goldman Sachs was not immediately available for comment.

"The telecom issue is certainly something we're watching" in the bank sector, says John Wimsatt, managing director of bank research at Friedman Billings Ramsey in Arlington, Va. "People think it's very significant and a somewhat systemic issue given the economic slowdown."

Hedging

For instance, investors are keeping a close eye on Winstar, despite a bullish earnings report this past week. The New York-based telco, whose stock has tumbled about 75% in the past 12 months, thinks things are looking up, saying it expects to break even in cash flow during the second quarter. Last year Winstar lost $1 billion on $759 million in sales, and is currently about $3.6 billion in debt.

According to trade publication Bank Loan Report, the Bank of New York (BK Quote - Cramer on BK - Stock Picks) led a $1 billion credit facility for Winstar last April. Citigroup (C Quote - Cramer on C - Stock Picks) acted as syndication agent, while banks including FleetBoston (FBF Quote - Cramer on FBF - Stock Picks) and the premerger J.P. Morgan also signed up with commitments of $50 million apiece, the report said.

Of course, many banks find ways to hedge their risk while reaping the benefits of interest payments and loan fees. These can include loan sales or the use of credit derivatives, which can protect assets against a change in value. J.P. Morgan Chase, which is one of the most active lenders in the syndication arena, is well known for a strategy of shrinking its exposure to about 10% of its original commitment, analysts say. That could come in handy given that the recent merger of J.P. Morgan and the former Chase Manhattan had doubled the bank's risk profile to some shaky credits.

Indeed, banks are not always left holding the bag. Bank of America (BAC Quote - Cramer on BAC - Stock Picks), for instance, was lucky enough to make a clean break from a $500 million credit facility extended to dying Loral (LOR Quote - Cramer on LOR - Stock Picks) affiliate Globalstar (GSTRF Quote - Cramer on GSTRF - Stock Picks).

The company has seen its stock lose nearly 98% of its value in the past 12 months and is currently the focus of a class-action shareholder lawsuit filed against Loral and its CEO Bernard Schwartz, alleging that investors were misled. Loral bought the $500 million facility from Bank of America in mid-November.

On the upside, says Wimsatt, U.S. banks are perhaps not as broadly exposed as some people think. He says recent data show them holding anywhere between 23% and 27% of outstanding telecom debt, with institutions holding 45%. "European and Canadian banks are holding a big chunk as well," he adds.

Richard Bove, banks analyst with Raymond James, says he is encouraged by the Lucent deal and thinks fears are overblown. The Lucent refinancing was "actually very promising," says Bove. "Everyone believed Lucent was going to fall apart and was supposedly unable to refinance its debt. It was going to be a huge loss for the banks. Then it refinanced its debt. It suggests that maybe there is a way to work this out."