Where does the “market that never was” go from here? With our own crystal ball back in the shop for further repairs, we thought it would make sense to review our experienced panelists’ reflections. We then looked at key contextual factors to plot some likely scenarios.
1) Interest Rates Are Going Nowhere But Up...
. . . which means those companies that have been living on the bubble face the possibility of sliding into marginal or even negative territory. Even though the Federal Reserve is maintaining its policy of historically unprecedented low rates, it is no secret that bond prices have been plummeting in anticipation of the inevitable rate rise. Underpinning that expectation is a U.S. economy that, despite stubbornly high unemployment, has by some key measures been in recovery mode for the last 18 months. Led by strength in the housing sector, the major driver across large swaths of the consumer economy, it is likely that credit demand will be fueled, resulting in additional upward rate pressure. The net impact: The domestic business climate will continue to improve, while weaker, creditsensitive companies slide into vulnerability.
2) Regulatory Incursion Is Picking Up Steam...
. . . adding cost and further hurdles for operating companies. The apparent poster child for new burdens, Obamacare, will tilt more at-risk companies into swampier space, but it is by no means the sole source of new pressure. In this regard, new levels of scrutiny are promised by, among other agencies, the Equal Employment Opportunity Commission—armed with a new commissioner, a new general counsel with a gimlet eye for corporate employers and a public hunger for monetary damages—to help endow its enforcement regime. Also jumping into the regulatory pool with renewed vigor is the Securities and Exchange Commission, with new reinforcements in the commissioner and enforcement ranks, a change likely to make life tougher for public companies. In a similar vein, the Consumer Financial Protection Bureau and its new director might seek to put a few quick notches in the bureau’s belt, potentially adding to existing issues in the finance industry.
3) S. 363 And Other After-Sales Activity Cannot Remain At Current Shallow Levels...
. . . particularly because the interest rate and cost trends outlined above are likely to push more companies into negative territory, logically putting a larger inventory of assets into play. While supply may be climbing, what will whet the collective appetite for these assets, which, as we saw in our panel, has flattened over the past couple of years? Two factors are on the horizon, either or both of which should come into play. One: The traditional ranks of distressed investors have not gone away, they have just been quiet—for too long. Like private equity groups that have been sitting on too much dry powder for too many years, there’s pent-up demand: The distressed investing participants need to put money to work, in ways they understand and where they can leverage their expertise. Two: If we are right about the impact of rising interest rates on filings, the quality and variety of available assets are going to look better to sharp-eyed investors; those equipped to operate on a global stage will, in all probability, start to find attractive plays amid cooling economic climates in China, Brazil and other markets accustomed to higher growth rates.
4) Underlying Economic Momentum Will Likely Force Banks To Open The Spigots Again...
. . . from a trickle to what will look like a steadier stream of new credit, simply to maintain their performance at market levels. While looser credit should logically help vulnerable companies in one sense, the banking establishment has also learned some lessons over the past few years that will linger as it refashions its lending book. Good companies will benefit from improved access to credit, but marginal companies will face a sterner test, finding themselves knocking on doors belonging to lenders of second or third resort and, thus, accepting the less attractive terms the lower-quality lenders require. You can write the script from there.
5) Valuations Will Have To Undergo A Transformative Re-Look By Finance Companies and Banks...
. . . to fully leverage their positions amid the emerging sustained growth trend. The primary financing sources in this or any other economy can no longer sit on their hands, hoping for a better day, because the hoped-for better day is here and now. As prices slowly inflate (or in the case of hot housing markets, quickly re-inflate), underlying asset values and institutional credit standards will have to be revisited in order to keep capital at work on a competitive basis. As with the “spigot” analogy, that’s likely going to be good news for companies with strong EBITDA pictures, but it may leave the less well-situated companies with no better options. In fact, it would not be illogical to anticipate that the distinctions between the “haves” and the “have-nots” will become even starker.
Net net, there’s a confluence of factors building, which augurs well—or at least decently—for a recovery in market activity. A rising interest rate environment, more assets in play of better variety and quality, all coupled with pent-up demand for the distressed investing class, aggregate to what appears to be a more hospitable climate for the entire distressed asset ecosystem of creditors, investors, transactional support and, strangely, even debtors who should encounter a more active market for their estates. In the process, maybe we go from the “market that never was” to the “market like it’s supposed to be”—the new normal—going forward.