Caterpillar bond sale illustrates credit crunch

CHICAGO, Sept 26 (Reuters) - When a unit of giant manufacturer Caterpillar Inc CAT.N went to Wall Street this week looking to borrow $1.25 billion as part of its normal financing operations, there were lots of reasons to expect the exercise would be anything but normal.

In the end, the capital raise wasn’t as bruising or costly as it could have been given the shattered state of the U.S. banking system -- though it did illustrate how much the financial world has changed in the space of a few weeks as a result of the ongoing crisis.

Things didn’t look propitious as Caterpillar Financial, the company’s captive finance arm, entered the market. As one after another of Wall Street’s biggest names fell in recent weeks, banks began hoarding cash and investors, unsure who the next victim would be, went on strike.

As these key players exited the corporate debt market, the lending pipeline narrowed dramatically. Things got so tight at one point last week, according to Caterpillar’s chair and chief executive, that all lending -- even to the highest-rated corporate borrowers -- ground to a halt.

“For a day or two, all markets for medium-term notes were closed to anybody,” Jim Owens told Reuters on Monday in an exclusive interview at a trade show in Las Vegas.

When Caterpillar entered the market on Tuesday, it was the first major issuer to retest the waters. A lot of people were watching -- and holding their breath.

To no one’s surprise, the interest rates Caterpillar Financial was asked to pay were higher -- a lot higher. When the dust cleared, lenders had forced the company, a unit of the world’s largest maker of construction and mining equipment, to pay about $15.6 million more per year to borrow the final amount than Caterpillar would have paid on the same loan just a year ago.

A number of analysts expressed shock at the premium the blue-chip company, untainted by the financial scandal, was forced to pay.

“This is very disturbing because Caterpillar is an industrial company, unsullied by association with the credit crunch,” said John Jansen, a former bond trader with the Open Market Desk of the Federal Reserve Bank of New York who now authors the “Across the Curve” bond market blog.

“If it takes that much concession to sell a solid stable industrial, what might the outcome be when a large financial seeks to tap the market?”

To be sure, $15.6 million isn’t pocket change. But for Caterpillar -- which expects to shell out an extra $550 million to $650 million this year just to keep pace with higher steel and other material costs -- the $15.6 million it paid to access the credit markets during their worst week since the Great Depression looks like a bargain.

As he reflected on this week’s deal, Eli Lustgarten, an analyst at Longbow Research, chose to accentuate the positive.

“Everyone is nervous,” he said, “and in a nervous environment, the price of credit is going to go up. And that’s what you see with the Caterpillar transaction. But the key thing is, they got it done.”

Caterpillar had good reason to be happy with the terms. When it came to market this week, the company originally wanted to raise about $500 million of the $1.25 billion total using 10-year notes. Lenders were happy to oblige -- but demanded the company pay a premium of 325 basis points over the comparable 10-year Treasury.

A year ago, those same lenders only asked for a 130 basis point premium over the 10-year Treasury. So Caterpillar’s borrowing costs had spiked 195 basis points.

But during that same period of time, the average premium that A-rated corporate borrowers have been required to pony up has jumped 331 basis points, according to the Merrill Lynch U.S. Domestic Master A-Rated Index, a benchmark for corporate bond performance.

The Peoria, Illinois-based company declined to comment on this week’s debt offering. “Our standard practice is to not discuss the strategic reasons for a particular issuance or the decisions involved in the exact timing of any issuance,” it said in a statement.

But actions speak louder than words. Caterpillar liked the rates it was offered on the 10-year notes so much that it decided to borrow an additional $50 million, bringing the debt sale total to $1.3 billion.

“Is the credit crisis preventing companies from doing business? Is the crisis spreading from Wall Street to Main Street?” said Lustgarten.

“The answer is yes, the markets are showing some signs of worry. But they’re still functioning.” (Editing by Gerald E. McCormick)