Whose company is it anyway?
Wednesday, 26th September 2007 by Phil Thornton
The issue of who owns your company used to be a simple matter. You had an overdraft or loan facility with your bank and your shareholders owned the equity.
But the globalisation of capital has changed that. Not only is there a demand from investors to find lucrative havens for their money but the products on offer have become mind-bogglingly complex.
The most controversial are based on the resale of corporate debt. Investors are keen to buy into the syndicated packages of corporate debt being offered by banks.
These are then converted into an alphabet soup of acronyms – CDOs (collateralised debt obligations), CLOs (collateralised loan obligations) and even ABCDSs (asset-backed credit default swaps).
The unifying factor is that it puts the debt one or two removes from your bank.
Another novel feature of this new era of debt management is the emergence of non-bank investors, such as hedge funds and insurers. Leveraged debt issuance in the UK reached $90.3bn (£45.6bn) last year, a 51 per cent rise on 2005 and almost half of the rest of Western Europe put together.
The insatiable demand by investors for debt has made it a sellers’ market for companies that can cut the interest rate and demand less onerous terms and conditions. All in all, it seems a perfect time to refinance one’s company.
That, however, is probably how it seemed to sub-prime mortgage borrowers in the US before interest rates rose and house prices fell. Without intending any comparison between Americans with dodgy credit records and the average British corporate, it’s hard to escape the nasty parallels between the two debt markets.
Strong demand for securitised assets, combined with benign conditions, encouraged investors to take on risky assets. At the same time, there was a fall in the level of due diligence. This allowed more financially insecure customers to take on debt.
Once the first ones defaulted, the investors quickly demanded settlement by the banks, which in turn stopped offering new loans.
The Bank of England is worried about a similar situation in the UK corporate credit market.
The current economic upswing has encouraged companies and banks to take on more risk. However, when the downturn comes, those same banks will be quick to sell on their debt to a vulture fund for as little as 10p in the pound, making the position even more opaque for companies.
So finance directors are in a bind. If they come to the board saying they have spurned a host of low-cost debt packages in favour of a traditional, pricier loan, they may well be shown the door.
On the other hand, they don’t want to be responsible for signing up to a complex package that they will have to unpick if things turn sour.
FDs whose banking arrangements are due for renewal will find a disorderly queue at the door. Interest rates will be competitive and covenants will be light. But few will have the time to assess each package.
In fact, few will have the skills needed to do so. The inevitable solution is to bring in business advisers to oversee the exercise.
The truth is that monetary conditions are still benign. Just as people who heeded the voices of doom concerning the housing market missed out on 184 per cent capital appreciation in the past decade by renting, so FDs who shun cheap refinancing deals will cost their shareholders dear.
But that is no excuse for failing to carry out due diligence now – it will pay dividends if the crash ever comes.
