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Thursday, 14 December 2017

Up Front: Sobering moments

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A Hungarian currency trader makes a phone call at his desk in Budapest

A Hungarian currency trader makes a phone call at his desk in the dealing room of a brokerage in Budapest November 25, 2011. Credit rating agency Moody’s cut Hungary’s debt to “junk” grade late on Thursday, dealing a blow to Prime Minister Viktor Orban’s unorthodox economic policies and prompting his government to denounce the move as a “financial attack”. (REUTERS/Bernadett Szabo)

It was another terrible week. Wherever you looked disaster was near at hand. The Germans and Italians endured close to ruinous bond auctions; Belgium, Portugal and Hungary were downgraded; and the Norwegians took a kick at an already fragile SSA market by apparently walking away from Eksportfinans, with the repercussions felt as far away as Japan, on which the export agency relied for much of its funding.

But some of the most sobering moments came from conversations with bankers attempting to broker deals between potential investors and banks hoping to sell vast swathes of their assets.

Quite simply, many of those bankers are convinced that such sales are not going to happen in the volumes necessary. On the one hand, banks can’t sell at too great a loss because doing so eats into their capital. On the other, investors are not willing to pay anywhere near the levels banks consider necessary.

That stalemate matters because, with banks shut out of interbank markets and barely able to raise funds (certainly at reasonable levels), they were relying on asset sales to bring down their risk-weighted assets – and therefore improve their capital levels – and to raise money to fund themselves.

If those sales don’t happen, it’s hard to see how some banks are going to find the money to repay their share of the €1.7trn of bank debt due to mature over the next few years.

Rule of dumb

As currently proposed, the Volcker Rule could make access to the high-yield bond market substantially more difficult. This is because, according to a note from law firm Paul Hastings, the rule may require banks to “hold for investment” for at least 60 days high-yield bonds that remain unsold after an underwritten offering.

In its present form, the rule risks damaging not only the high-yield bond market but also the bridge loan market, as banks will find it more difficult to refinance those loans.

Far from reducing the risks that banks take, the rule, at least when it comes to high-yield bonds, will do the opposite.

Bridge loans are typically taken out in the high-yield bond market as a way for bank lenders to reduce balance sheet risk. Limiting their ability to transact such deals could force banks to hold more, not less, risk on balance sheet because it will be more difficult and expensive to take out bridge loans via the bond markets.

Banks are lobbying hard to get various aspects of the rule relaxed. Some of that lobbying is designed to allow some of the more dubious practices of the credit boom to continue. But not all of it is self-serving and in this instance US regulators would do well to listen to banks’ entreaties.

Enduring the glare

The price of admission into public capital markets is the harsh glare of public scrutiny and the risk that investor opinion will turn painfully against you and inflict real damage to your business in the process.

Daily deal provider Groupon again furnishes the extreme example.

On November 18, the company was still flying high after its IPO a fortnight earlier, trading at a 30%-plus premium to issue. Within a matter of days the tables had violently turned, and the stock plunged to a 15% discount to the issue price.

Groupon’s rapid descent touched off a wave of fresh doubts about the investment proposition offered by the latest rush of social media-related technology companies (some now public and some hoping to be).

But why now? The key trigger was the end of any counterbalance to Groupon’s legion of critics.

The stock became more available to borrow and short and given the negative attention it has received in the past, Groupon could hardly have been a more attractive short-selling target.

Importantly, the exercise of the underwriters’ overallotment option meant there was no longer any opportunity for the underwriters to stand in the way of the selling stampede (explaining why the sell-off only began in earnest last week).

Many supposedly long-term supporters, keen to avoid another end-of-year performance hit, also did the Wall Street Walk. Long-term is an expression long since expunged from this market.

Likewise, the simultaneous collapse in the stock prices of other recent tech IPOs, such as LinkedIn – as insiders have inevitably looked to crystallise their holdings after a mandatory lock-up period – further highlighted the challenges facing underwriters when they price IPOs whose valuations rely on little in the way of fundamentals.

Successfully bringing these types of companies to market is proving far harder than the hype around social media suggests.

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