LIBOR Traders Are Predicting Fed Rate Increase

LIBOR traders, who set the inter-bank lending rates that are tied to at least $350 trillion of financial products, are projecting a Fed rate increase. 

The chart shows that traders expect a 0.25% rate increase to take place in the next 3 to 6 month period.

The 30-day LIBOR went up 0.25% either in anticipation or shortly after Fed increased the rate by 0.25% in December 2015.

LIBOR rates are tied to floating rate mortgages, most business lines of credit, money market funds, short duration corporate bonds, etc. LIBOR influences costs of doing business and greatly impacts corporate capital expenditures.

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As Credit Tightens, Entrepreneurs and Dealmakers Turn to Non-Traditional Lenders

After what occurred in 2000 and 2008, one should have expected banks and other common lenders to become more regulated and scrutinized. Though this may have created some inconveniences for some firms, it helped open the door for others. Banks have established more rigorous qualifications for companies to be given financing, and capital constraints and shareholder activism are becoming more influential when it comes to publicly traded business development companies (BDC). For middle markets in particular, this has allowed alternative lenders to emerge and acquire more market share than would otherwise have been possible, because of the vast amount of competitors.

“Banks have established more rigorous qualifications for companies…”

With public perception of banks still relatively low and regulators keeping a close watch, it is not difficult to see why banks want to keep a low profile and not conduct any business that may raise a red flag. In 2015, 25% of middle market loan transactions featured deals of more than 6x EBITDA; an example given by regulators as a possible red flag. It is why most traditional bank lenders are currently staying away from making leveraged loans deals on private equity firm deals.

Similarly, BDC’s are also currently sourcing fewer deals. They are currently facing difficulties in raising capital, because as of March, most were trading below book value. This has prevented many from issuing new equity for funding. Without cash to fund new transactions, the only alternative would be to fund from repayment on existing loans.

Collateralized loan obligation (CLO) issuances are on the decline. About $4 billion in CLOs were priced for what was most of the first quarter, a harsh decline from almost $17 billion during the same time period just last year. During 2013-2015, the CLO market grew by more than 50%. However, the market has decreased by about 50% during the past year. Additionally, under the Volcker Rule which is set to take effect at the end of 2016, managers will be required to hold 5% of their CLOs. Though many managers are attempting to adapt and others are selling off their CLOs, it remains to be seen how the rest of the market reacts.

Finally, we come to the benefactors. Alternative lenders are currently taking advantage of the current state of the lending market with great vigor. A great advantage they have is being able to act quickly and with much flexibility. This is possible, because most are either non-regulated or regulated far less than traditional lenders. These alternative lenders are beginning to develop close relationships with private equity firms for these particular reasons, which helps PE firms acquire financing for deals, and as a result fund the investments in their portfolios. Small Business Investment Company (SBIC) funds are also benefiting from the current state of the financing landscape, especially considering the two new regulatory changes made at the end of last year; reduced registration requirements by advisors and the amount of capital an SBIC can control has been raised to $350 million from $225 million.

Though the availability of attaining financing has become more difficult, not all have been affected negatively. The financing landscape will improve, but in the short-term, in its current state, we should expect alternative lenders to become more prominent players in the space.

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PMI Index Signals Industrial Production Rise in 2H16

Purchasing Managers Index 1/12 rise signals industrial production rise in the 2nd half of 2016

The Purchasing Managers Index (PMI) 1/12 rate-of-change rose for the third straight month in February, confirming that a cyclical low occurred in November 2015. The upward movement in the 1/12 rate-of-change suggests that the current trend of decline in the US Industrial Production 12/12 is likely to transition to rise in the second half of 2016.

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Unlocking resources through better corporate cash management

Companies call on the full resources of their cash management, as they need to grow, execute CapEx or acquisitions.

But going an extra step gives financial managers a chance to help benefit their organization in a less-than-usual way.

The financial manager has an excellent opportunity to contribute strategically to a company's growth, by demonstrating how working capital can be leveraged to serve as a financing and risk management tool in conjunction with, or in addition to, traditional funding methods. This can help strengthen the capital plan and help improve the debt structure.

The benefits of freeing up cash to grow a company:

Reduced financing requirements

• Existing cash is typically the cheapest form of financing. Using it to finance growth, including for CapEx or acquisitions, can reduce the external financing expense of stock or bond issuance. 
• The cash released from
  
  working capital in this instance, should be valued at a weighted average cost of capital (WACC) or, alternatively, the cost of financing the growth should be included in the capital plan typically developed by the financial management team. 
• In the example above, established working capital standards, can guide a company to release a sizable amount of cash, which applied at a well structured WACC can generate benefit for the company.

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Look out for financial ratios and credit ratings

• Credit rating agencies like D&B review company balance sheets. 
• Rating agencies usually look upon increases in free cash flow as a positive factor during this process; however, it’s important to note that agencies may penalize companies that ineffectively manage their working capital compared to their peers.

A positive impact on company strength and valuation

• When looking at a discounted cash flow valuation, the release of working capital that can be achieved by the company would translate as an increase in cash, ultimately improving the valuation of the company.
• This needs to be looked at carefully and conservatively to ensure that all improvements can indeed be achieved; the finance team is in a prime position to evaluate this.
• When using weighted average cost of capital, including working capital release in the calculation may boost a company's financials through a one-off increase in free cash flow.
• Although working capital is priced into a corporate acquisition, the full potential of the synergies often go unrealized when the treasury team, which handles working capital daily, isn’t involved early in negotiations.
• Working capital is often looked at with more detail in private equity deals, as it is the goal of financial sponsors to maximize asset allocation and drive quick shareholder returns.

More funds for growth

• Cash unlocked from working capital may help a company grow more quickly, facilitating integration and reducing the execution risk from a cash flow requirement perspective.
• Strategic events such as mergers, acquisitions, sales, reorganization, etc. provide the perfect opportunity to review the working capital position of the company. 
• Although the review of working capital and improved management of cash may require some efforts, (improve processes, deploy new banking solutions, and change policies), uncovering these funds can sometimes can release sizable cash to the company's balance sheet.

Released cash can add up quickly

Even a one-day improvement in working capital management parameters can have a profound impact and the finance management leadership plays an important role in this.

Working capital release techniques could be bank-led solutions such as factoring, supply chain finance and card solution, or internal re-engineering such as supplier and customer payment terms standardization. A centralized liquidity structure automated at an in-house bank level can also move the needle in terms of the funding mix of long-term versus short-term debt structures.

As another internal example, larger companies execute ‘payment runs’ on a weekly or fortnightly basis. As these payment files usually are designed to have all payments processed on that same day, the company often ends up paying invoices earlier than their due date (invoices due in the following

week or two) to avoid the cost of executing daily payment runs. Changing this process so that payments are ‘warehoused’ at the bank level until the invoice due date can be a quick and easy way to release working capital, often resulting in a three-day extension of Days Payables Outstanding.

The example above illustrates how the finance manager’s knowledge of the organization’s cash flow can help establish what the achievable extension of company's days payable outstanding is, and therefore, what the subsequent reduction in the cash conversion cycle would be.

Best practices to consider

• Involve finance staff as often as possible in to decision-making process.
• In M&A situations finance team can propose the use of cash from working capital as a funding option.
• Identify the focus areas for working capital release.
• Prioritize the deployment of processes and policies, which can quickly release cash from the working capital to accelerate the funding growth.
• Centralize treasury operations: consider using shared service centers to standardize payments flows and leverage funding from an in-house bank with automated cash concentration structures.
• Hand off functions to banks, such as the financing of some of the strategic suppliers through a supply chain finance program, or the management of some local processes (such as payment file translations).

Note: Calculations of Working Capital used for the examples in this document follow the bellow formulas:

Days Payable Outstanding [DPO] = (Trade Accounts Payable / Cost of Goods Sold) * 365
Days Receivable Outstanding [DSO] = (Trade Accounts Receivable / Revenue) *365
Days Inventory Outstanding [DIO] = (Inventory / Revenue) * 365
Cash Conversion Cycle [CCC] = DSO – DPO + DIO

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Are high-yield bonds and floating-rate loans at risk?

The constant pursuit of yield in this low interest rate environment might have pushed the demand for high-yield bonds and floating-rate loans high enough to impact judgement of banks underwriting and backing new issues.

Banks are frantically underwriting high-yield bonds and financing syndicated floating-rate loans, counting on investors to absorb everything coming to markets.

Interest rates for new bond and loan issues have dropped, prompting borrowers do more acquisitions, buybacks. etc.

Private equity fund operators are some of the largest biggest users of high-yield bonds to arrange leveraged and management buyouts. Floating-rate loans are used in buyout deals as well.

Low interest rates, willingness of banks to underwrite bonds and loans, and readiness of investors to acquire bonds and invest in loans have pushed mergers & acquisitions and buyout activities to new highs. Valuations of companies being snapped up in auction style sales are breaking records after records, reminiscent of 2007.

The illustration to the left, a deal tombstone published in the Dow Jones Private Equity News, speaks to it. In this case, a large private equity and LBO operator borrowed $1.75 billion to supplements its own funds to acquire more companies. Keep in mind that acquisitions are done by issuing high-yield bonds, to add to the equity. As such, banks are lending loans to add to the equity of the buyer, all while still lending more via high-yield bonds. More leverage to execute more purchases. All loans and bonds will end up in investor accounts, through mutual funds and ETFs, in a very short order.

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The effects of bulging corporate purses.

High cash levels, accumulated by S&P 500 corporations, are being put to work. Above charts are showing growing levels of capital expenditures, M&A activities, dividends, and stock buybacks by the nation's largest corporations.

If sustainable, this will benefit the economy. Capital expenditures can add to the industrial growth. Dividends and stock buybacks will probably add to consumer spending and housing sector strength. Corporate mergers and acquisition activities may strengthen equity markets.

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Clicking the Like button on various social media platforms, such as LinkedIn, Facebook, etc. does not constitute a testimonial for or endorsement of Redmount Capital Partners LLC or any Investment Advisor Representative. “Like” is not meant in the traditional sense. Posts must refrain from recommending investment advisory services or providing testimonials for our firm, since they are strictly prohibited. Please understand that we are required to delete such posts, since this is a regulatory requirement.

Are property valuations chasing future rent increases?

First, let pictures (charts in this case) speak their 1,000 words. 

Commercial property market valuations, in almost all categories, have eclipsed 2006-2007 picks. 

Valuations are even higher in key markets like Tri-State, Boston, Washington DC, Southern California and San Francisco.

" Capitalization rates have dropped to historical lows of 3% to 4% for industrial and multifamily deals in particular." Orange County Business Journal wrote on March 16, 2015.

Yet the largest and most sophisticated investors, led by pension funds, private equity funds, and insurance companies, are in the midst of buying spree.

The rational on the part of buyers? Potential rent increases in the near future. It seems the largest aggregators of capital believe in the continuing economic growth.