ASK a senior banker about the health of the financial markets, and he (or she) will tell you that the illiquidity in global capital markets is as bad now as it was in August. That was the month when Northern Rock, the mortgage bank, was forced to go to the Bank of England for emergency support.

The faint signs of improvement that were around at the turn of the year have gone - once again banks are unable to trust each other enough to lend.

What that means is all the action taken by the Federal Reserve, the European Central Bank and more latterly the Bank of England over the past seven months to restore confidence in the interbank lending markets has made not a jot of difference, and the recapitalisation of Wall Street by sovereign funds hasn’t helped much either.

What is more worrying is the data coming out of America mean that even if it isn’t technically in recession, it might as well be. The US employment data on Friday showed a further 63,000 non-farm workers losing their jobs - the second consecutive month that this occurred. The last time America had two consecutive months of job losses without being in recession was in 1952. The combined impact of recession and redundancy are two words that spook financial markets and rein in consumer spending.

The Federal Reserve is clearly concerned enough to have announced a further emergency set of funding last week. The central bank increased the amount of loans it will auction to banks tomorrow and on March 24 to $50 billion (£24.8 billion) each, up from the $30 billion apiece originally planned.

When times are tough, bad news can come from unexpected places and it can be far worse than you had imagined.

Last week, like a bolt from the blue, came the revelation that Carlyle Capital Corporation, the mortgage-backed securities fund, had failed to meet calls for cash from some of its lenders. The portfolio is no tiddler; it is worth more than £10 billion. And remember, the fund invests not in sub-prime junk but in securities that are rated triple-A.

And slowly, slowly, investors seem to be waking up to the uncomfortable truth that even the most apparently robust companies may face problems if, as we fully expect, the credit markets remain unforgiving for some time to come.

Last month, we wrote in these pages about the mighty General Electric of the US. Even it has not been immune to the strains in the credit markets – hardly surprising for a corporation that makes much of its reported profits from borrowing, lending and investing. It is a bank within an industrial company.

We pointed out then that over the past 12 months the cost of insuring against default on loans by GE Capital - the General Electric vehicle through which most of the group’s borrowing is done - had increased tenfold within a year.

In the subsequent three weeks, that cost has risen by a further 50%. And, interestingly, Wall Street is beginning to voice some quiet anxieties about GE Capital’s exposure to the debt markets.

Merrill Lynch analyst John Inch published a research note last week after going through GE Capital’s “10-K” filing – in effect the company’s detailed annual report.

The company got out of sub-prime lending last year. But, Inch remarked, “the company retains vast commercial real-estate holdings that could be subject to future write-downs as global commercial real-estate values decline. GE Capital also has billions of dollars of exposures in non-sub-prime mortgages, sub-prime consumer and nonUS auto lending”.

He went on: “Off-balance sheet securitisations that could be uncertain - commercial real estate, residential real estate and credit-card receivables - increased 51% year-on-year.”

General Electric is financially robust. GE Capital is good at managing risk. But relying heavily on the wholesale commercial-paper market is not comfortable - even for the most blue-chip companies.

There are going to be some more nasty surprises. There are a lot of very leveraged situations that have yet to unravel, from infrastructure funds to hedge funds to private equity – and we haven’t heard a squeak yet from the Japanese banks.

Melrose well placed

NOT all deals have been stymied by the credit crunch. One that is in better shape than many think is Melrose’s bid for FKI, which makes turbo generators and baggage-handling equipment. Last week, it upped its cash and shares offer to value FKI at £500m, excluding debt.

Melrose’s chairman and chief executive, Chris Miller and David Roper, with the help of JP Morgan Cazenove, have now raised sufficient bank finance. This will give the private-equity firm the ability to repay FKI’s €600m (£456m) Eurobond as well as a £120m working-capital facility that has to be repaid next year.

Melrose then has the flexibility to reconfigure FKI, if its bid is successful. Its offer has been raised from 70p to 85p a share, which includes a 3p dividend due in October.

Trouble at the top

BRIAN McGOWAN, Rentokil Initial’s chairman, has said he is heading for the exit after the group’s recent profit warning. To make matters worse, his nonexecutives have said they don’t want to step into his shoes. And another search is under way to identify a chief executive to replace Doug Flynn. None of the internal candidates is up to scratch.

john.waples@sunday-times.co.uk

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