One Possible Consequence Of COVID Crisis: A Rethink Of How Companies Finance Themselves
Earlier this week, I highlighted some excerpts from a note penned by SocGen's Andrew Lapthorne, who addressed what is perhaps the most vexing dilemma for market participants struggling to formulate a strategy at a time when, presumably, opportunities exist in the wake of one of the most spectacular equity routs in modern history.
Remember, it wasn't just the scope of the decline last month that was so "impressive" (and I'm note sure "impressive" is the right word there). Perhaps even more remar
I remember when the banks were told to re-capitalize during the GFC. It was the secret code to sell stocks. That was a big downleg in the market. Was it Paulsen? Geithner?
While the trigger for this crisis was not the banks nor a self reinforcing loss of confidence, there may be similar outcome if the cheap money window closes.
To lever up was always to lever down, it’s just that the two sides of the same coin relationship was convenient to ignore, if not essential to ignore for CFOs trying to progress in their careers. Let it be noted that no real small business entrepreneur in the US could ever get away with the kind of irresponsibility that passes for good stewardship in these board rooms. They would be forced into bankruptcy, their homes would likely be seized, and they’d essentially be banished into credit purgatory for at least a decade. So, perhaps some of the systematic moral hazard is now coming home to roost, as it should, unless we desire to live in a plutocracy forever.
If you invest in an over leveraged company trading 20%+ above historical norms, I suppose a 33% drop could inspire utter despair if your assumption was moral hazard did not exist. For most nvestments in 2008, it did not exist; the question of the day today is whether or not this assumption holds true again.
The very first rule I learned in my first fiance principles class, the rule that should guide all firms managing their capital structure was: “Always issue the weakest security first.” The weakest security from a company’s perspective is common stock because it carries no legal obligation to pay anyone one anything, unlike debt which is generally entangled in many obligations and often presents a veritable minefield of contractual provisions which can overpower even a well meaning firm. While financial leverage may partially magnify the return of net income on equity, when overdone it can be a disaster. Low interest rates don’t pay bills. Even at low interest, too much debt can reduce a firm’s financial flexibility a great deal. Something like a third of our outstanding IG corporate debt is rated just above “junk.” The rating agencies were generally too generous before the “great unpleasantness” in 2008. I suspect they are again and the junk bond market is about to become a growth market.
One can only hope, it makes so much sense in a technology driven environment to be as nimble and agile as possible, but as long as boomers insatiable demand for fixed income persists and executive comp is stock price driven, I don’t see much changing.