COPING WITH THE CREDIT CRUNCH: CREDIT CAUTIOUS

What have you seen in credit availability over the past eight months or so? Is it getting tighter or looser?

Valenta: I would say generally it is still really tight. With many banks and many of our customers it is still fairly tight. I can’t say it’s loosening, but I can’t say it’s getting tighter.

Lewis: There are a couple different ways I would look at it from a Reliance perspective as a $10 billion public-equity and debt company. Over the past six months it would have been extremely difficult to raise new funding at our level—we’re a triple B minus, so we’re investment grade. But even at that level, companies were having difficulty raising additional debt in the various credit markets that freed up a little bit earlier this year [but then] tightened up again. Now it’s opening up again. So currently credit seems to be a little bit more available and the cost is a little better. But we’d still be paying a significantly higher cost today than for the debt that we currently have in place.

Talking to a lot of commercial bankers, their business is probably more profitable now than it’s ever been because they’re able to charge a much higher margin. [But] good companies can get credit.

Berlin: Luckily for my company, our credit facility doesn’t expire until early next year. But LIBOR [London Interbank Offered Rate] has come back down to its more historical relationship to prime, so LIBOR now is roughly about .5%, and prime being at 31⁄4 [as of early June]. The bank has margin, if you will, to borrow money from other banks, then loan it out and make a spread. … [Banks] now want to make it LIBOR plus 41⁄2—that would raise your rate from the current 21⁄2 to 5, in essence doubling your interest rate. The effect of that is raising the borrowing costs for companies in our business at a time when business levels are reduced and makes it more expensive to borrow money.

Britton: Credit availability is better in Canada than it is in the U.S. I think that the banks in Canada are in slightly better shape than the ones in the U.S., which does help. They work under tighter rules than some of the U.S. banks. [Canada’s highly regulated national banks have a lower ratio of loans and investments to capital compared to U.S. banks, which limits the banks’ risk. U.S. banks went as much as twice as high on the loan-and-investment side of the ratio.]

Has your financing historically come from banks or public markets, or have you been self-financed? A combination? Has that changed during this credit crunch?

Lewis: Historically we’ve raised most of [Reliance’s debt] through credit facilities and had done some private placement notes. Starting in 2006, we entered the public debt market and did a bond offering. We haven’t done anything to change our capital structure because we’ve got adequate availability, and [with] the structure and cost of the debt that we have in place right now, there’s no way we could replace it at the cost we have. We are looking to just maintain what we have.

Britton: We have a U.S. high-yield bond outstanding, plus two banking syndicates, and we’ve had that for more than 15 years. It’s been something we’ve typically had, whereby we have our equity, and then a chunk in long-term debt. But then we use the banking facility to fund the ups and downs in the working capital.

Berlin: We’re privately owned and we borrow from the banks. The cost for money for everybody in the whole supply chain has gone up. We do currently have an industrial development bond that we originated three years ago and there’s seven years more to go, and then we’ll be paid off. If we were to [originate] that bond today, our rate would be a couple percent higher. We’re paying 5-point something, and General Electric, who underwrote that bond, said if we were to repeat that again the rate would be in the 7s somewhere. It wasn’t a huge bond, $2.5 million.

How has the credit situation affected your purchasing from producers? How has it affected ongoing or planned projects?

Rogers: There are three or four items that we have deferred until market conditions change, including issues with our IT systems upgrade to SAP [software]. And we’ve deferred a couple of other what I would call opportunistic expansions—not anything we needed to do.

It’s not a matter of liquidity or availability of capital, it’s really a matter of prudence. We’ve been—as have most of our competitors—in an aggressive mode of trying to reduce our inventory to meet the levels that we were seeing in terms of sales in the market. We certainly have purchased far less than we have historically, but that had nothing to do with accessibility to credit. It was really more just managing the inventory levels down commensurate with the market activity.

Valenta: I would say the economic recession has had more impact limiting our original planned growth. There are a number of strategic growth plans that we have on hold primarily because the demand levels are down right now.

Lewis: From a credit perspective, that has not impacted our purchasing at all. From the fact that there’s relatively no business—and I shouldn’t say “no business,” we’re still selling a lot of metal—but more based upon just demand levels, we have certainly cut back on our purchasing activity.

Berlin: Because our rate has not yet reset, it hasn’t affected us at all. In the bigger picture, everyone’s cost is going up in the system. Plus, as your inventory becomes worth less as the price declines—it’s declined rapidly since last summer—that’s collateral you use to borrow money. That collateral becomes worth less. Banks also loan money on machinery. The machinery market has tanked, and so that used-equipment valuation has become worth less. … Typical collateral for a company would be their real estate—some companies own their own buildings—and there’s been a decrease in value of real estate. Equipment is worth less, real estate is worth less and the banks are raising the rates, so you have the availability of less funds overall, and a higher cost of those funds overall.

What have you heard from your customers in terms of obtaining financing to buy from you? When did you start to see a slowdown?

Lewis: It happened pretty quickly, the beginning of November of ’08 [for Reliance]. We don’t sell metal to the auto and appliance industries—companies who sell more directly to them were hit earlier than we were. We have a pretty big chunk of business that’s nonresidential construction.

Order patterns of our customers have become smaller and more frequent, [but] that’s actually the type of business that Reliance does every day. We believe that until there is a general comfort level that prices have … stabilized, people will continue to just buy what they need and won’t buy any stock material.

Rogers: [During] 2008 as a whole, volumes were down from 2007, but particularly in the third and fourth quarters, and into the first quarter of 2009. The buying patterns have been at levels we haven’t experienced in decades. It was sliding downward, and then certainly took dramatic drop-offs in the fourth quarter and the first quarter.

Berlin: [We started to see a buying slowdown in] the fourth week of October. We were having a good October, but in that last week our customer releases just slowed down and our last few days of the month were terrible. October was a good month, but that [slowdown] then extended in November and December and it was like, whoa. It was like the spigot was just turned off.

Britton: It was like going to a cliff, and then falling off in the last quarter of 2008. All of a sudden people realized that either they needed to conserve cash or their banks were saying, “No, you can’t borrow more.” Or else they just weren’t selling as much at the other end, so they said, “We better slow down on our buying because we don’t want to have a huge amount of inventory.” And I’m sure there was some of each.

Did the number of customers’ orders decline or did they stop suddenly? Or did their order sizes become smaller over time?

Berlin: Everyone got afraid. The fear was kind of like a domino effect. You had the credit meltdown in September, and it took a month for the sense of what was going to happen from it to percolate through the system, and everyone’s buying just froze shut. And then all the buyers lost their visibility for their companies to project their own sales, and so the buyers were told, “Don’t buy so much, we don’t know what we’re going to sell.”

The numbers in November, December, we probably saw a 50, 55% decrease in our volume levels over September, October. That’s a big number. There was a slight recovery in January, but if you look at [the Metal Service Center Institute’s] numbers for the shipments out of the service centers in the first quarter, [they] were down by 40 to 43% across the board for service centers in the aggregate versus the first quarter of ’08. One month I was 37 and they were reporting 42, so everyone was in the 35 to 45% range in terms of a decline in business versus the same period a year ago.

Valenta: Some customers have said that their inventories are low and they would like to replenish, but they are constrained by bank financing, and some infrastructure projects are delayed while they’re working on financing. I’m not seeing a timing of when things will free up. In most cases we saw a decrease in the amount customers were buying. In a lot of cases, [they are] still placing the same number of orders, but the quantity per order is lower.

Have you extended credit to any of your customers? Has that changed?

Rogers: At any point in time we’ll have upwards of 20,000 customers to whom we’ve extended credit, outstanding balances with customers. Certainly we’ve been tighter [since the crunch began]. We’ve stayed on top of payment patterns more than you would in a typical environment.

Berlin: I give credit to my customers all the time, but I’m being very careful [now], as careful as I can be. If a customer was a few days late previously, say I gave them 30-day terms and they were a few days late a year ago, I wouldn’t have worried too much about it. Today I’m on the phone with them at 31 days and, depending on the customer, you may be on the phone with them at 27 days, saying, “Just calling to make sure you have checks coming scheduled for the 30th.” If I don’t get that check the 31st, 32nd day, then I’m calling them back saying, “The check’s not here and I hate to have to impact orders and releases, but if I don’t have a check I can’t continue to ship.” We’re spending as a company much more time having those kinds of conversations. If my CFO was involved in credit, say, eight hours a week, he’s [now] involved in credit two days a week.

Lewis: That’s a hard question to answer because we’ve got so many different customers and our credit function is decentralized in approximately 160 locations, and our people in the field are making credit decisions every day. But in the words of our credit manager, “You practice good credit policies every day and you don’t have problems.”

Rogers: We certainly have had situations where customers have had difficulty getting the credit they need to manage their business, and those are situations we need to work through. [We’ve seen] an increase in write-offs, and a stretching out of the DSOs [days sales outstanding]. But overall we’re pretty pleased with how well we’ve been able to stay on top of it and tried to avoid having any major issues.

Some companies have reduced working capital and costs. Have you restructured in any way because of the credit shortage? If there is a rapid pickup in demand, what kind of position will you be in to respond?

Lewis: We’ve definitely reduced our working capital to try to better match our customer demand levels. Through the fourth quarter of ’08 and the first quarter of ’09, we reduced our inventory by over $800 million. We’ve taken a significant amount out of our working capital. We’ve also made job cuts, but that’s kind of a business-by-business decision of how deep we go. We had cut 17% of our work force over that same period … and we’re continuing to evaluate that and take action, depending on how the market reacts. … If demand were strong enough, we would love to bring people back.

Berlin: I wouldn’t call it restructuring, but we have had a reduction in work force, and we’ve reduced our machine capacity, our manning of machines, by 40 to 50% since a year ago summer.

Rogers: We were a little bit ahead of the curve in that we were purchased by Platinum Equity in October 2007, and we’re on a fairly substantial restructuring program in terms of decentralizing a lot of operations and really readdressing the way that we go to market. On top of that, as the market deteriorated further, we took another set of actions to try to address our cost structure in light of the market conditions.

On the working capital side, [we’ve instituted] significant reductions in our inventory levels and our receivables, as the sales have declined, and similarly significant reductions in the debt levels that we have with our banks.

As to how our capital structure and the way our funding arrangement with the banks works, as our needs to fund additional sales—the receivables generated by additional sales, as well as the additional inventory we need to bring in to serve our customers—start providing us more accessibility to bank financing, we have a deal that’s sized to allow the business to come back. That committed bank financing through 2012 will allow us to fund the additional working capital needs under our existing bank deal.

Britton: We’ve reduced our costs by laying off people, reduced work weeks and salary reduction. [In February, Russel Metals announced 500 job cuts and reduction of executive and employee pay by 10%.] Working capital—it’s been basically managing the inventory and making sure accounts receivables are collected.

Have you considered any acquisitions? How has the credit crunch affected the status of any of these plans?

Berlin: We’re a mid- to smaller-sized company. I’ve been looking in this last year for a company our size, maybe half our size, who would be a good candidate to consolidate with. I haven’t found that candidate yet. I’ve seen some companies become available because they’re having difficulty, [but] I’m not looking to buy a company in trouble and rescue somebody. There are some companies out there that can do that better than I can.

Valenta: Because of the current economy and the current credit crunch [family-owned O’Neal is] cautiously reviewing any future acquisitions. We’re not closing the door on them, we’re still reviewing and considering, but it’s more difficult to do right now.

Britton: Not currently. And we would have to feel comfortable as to what the market conditions are and to see where we’re at before we want to be doing that.

Lewis: We have publicly stated that, during the credit crunch, we were not doing acquisitions until such time that we have more confidence in the market and the outlook going forward. But we’ve also said we expect there to be opportunities that come out of this, and that we will be positioned to take advantage of the right opportunities.

Rogers: There are some potential opportunities in the market. We’ve been an active looker, and we’ll continue to do that. There are certain deals we could do underneath the bank financing that we already have committed. For larger deals, maybe we would have to go back to the market, but there’s a lot of flexibility just in our existing deals to make some acquisitions and to take advantage of the market to try to add some good companies at this point. We’re actively looking, and we’ll always be actively looking.