The banking industry must walk a fine line between alleviation and financial responsibility. Where private investors are hesitant to step in, governments step in. Pension funds and other long-term investors, if structured right, might provide the “patient money” needed to sustain small community companies.
The aftermath of various epidemics has continued to test and upset economies throughout the world, but the banking and capital markets sectors can assist in steadying the ship. They can help small and medium-sized firms (SMEs), struggling industries, and developing markets through new, creative liquidity plays, ensuring that all sectors of the global economy emerge effectively from this crisis.
Lenders and financial market corporations must take the lead in all three phases of this rescue effort: the sovereign phase, the debt phase, and the equity phase. Many nations’ government assistance is anticipated to dwindle this autumn, after which we will progressively see economies sliding into stages 2 (indebtedness) and 3. (equity). Banks and fixed-income investors will carry the significant burden of supplying capital and liquidity throughout the debt period. When enterprises cannot service their debt and must restructure and recapitalize during the equity phase, private investors and public capital will be the key participants.
Banking firms that engage in phases 2 and 3 will need to look beyond short-term shareholder returns and consider the “broader context” – seeking possibilities that can help the more extensive economy while making sensible, prudent lengthy bets.
Debt (Indebtedness) Phase
From now on in the debt phase, financial institutions must first assess the landscape by analyzing their current credit book to determine their levels of exposure across different sectors and proactively determining where additional credit is required.
When companies start to extend loans, they will need to diversify their risk among several credit firms while regularly reviewing viability and credit capacity. In addition, they’ll need to establish criteria for determining who should receive relief and who should be restructured, which will avoid the creation of zombie firms that are permitted to continue operating when it would be in favor of society for them to default and reorganize. This will necessitate a delicate balancing act in which financial institutions must identify the actual strugglers while still seeking to be fair and equitable.
In the initial phase of economic stabilization, the banking sector served as a conduit for the central banks’ guaranteed loan programs for SMEs, in addition to providing average debt vehicles. However, due to uncertainty, regulation, and monetary policy, bank lending has remained sluggish since the 2008 financial crisis, suggesting that they are not the market’s cure for easing the flow of loans, even if the government supports them. This has created an opportunity for the shadow banking industry – capital market participants such as private equity – to enhance their direct private lending through debt restructuring or bridge financing. As a result, direct lending by institutional credit funds has been a dominant factor in SME lending in places such as the United States. In specific recent periods, these sources of capital have provided the majority of the credit.
During part 2, the government will support lesser credits, forcing the business to walk a fine line between alleviation and financial responsibility. This will be especially true when working with faltering industries. This is the time for Banking and Capital Markets participants to be vigilant of economic indicators to regularly re-assess the extent of the crisis and their capability to issue additional debt to borrowers on the verge of moderate viability.
Firms in areas such as travel, automotive, and energy are already seeking additional lines of credit. Once the public and financial sectors have reached specific levels, capital market participants will step in to offer direct lending and other types of debt. We are already witnessing an increase in whole balance sheet solutions for some of these ailing industries, such as creative sale and leaseback or financial engineering solutions that enable struggling firms to access their entire capital base to create much-needed cash flow.
“The first thing we focus on is trying to determine if a firm is a designated survivor, i.e., has the company done well before the crisis, and does it have a business model that is future-proof?” says Roger Bieri Head of Multinationals Clients at UBS. If the response is no, we work with these firms and external consultants to assess their business model, perhaps reorganize the business, and/or locate new investors.”
Requirement for tailor-made equity Solutions
Getting through this epidemic will need more than just finance for many firms. So far this year, 45 firms in the United States have declared bankruptcy, each with more than $1 billion in liabilities. By the end of the year, that figure might have more than doubled. In the small and medium-sized company sector, 50 percent of firms now believe themselves in severe financial distress, and millions have stated that they may have to close their doors permanently. To assist these struggling enterprises, the banking and capital markets industries will need to offer innovative, adaptable solutions throughout the equity phase. Such remedies must ease the transition from phase 2 to phase 3 and assist a broad range of struggling organizations, from giant corporations and industrialized nations to small firms and emerging markets.
“Our capital markets competitors are having a whole lot of talks with qualifying borrowers about arrangements that provide them access to the liquidity that is available,” says Bernie Mensah, President of Bank of America’s International Bank.
Companies want to employ three typical equity vehicles. The most upsetting is bankruptcy and recapitalization, in which current shareholders are wiped out, and new capital is used to repurpose assets. The second is additional stock infusions from either private or public sources, generally in preferred structures that allow new investors a more significant share of the upside. Converting current debt to equity is the third method for strengthening firm balance sheets and increasing accessible cash flow. Finally, lenders (both public and private) become owners as a result of this procedure.
This crisis brings a unique opportunity for the capital markets sector. Especially considering of a $1.6 trillion of dry powder available to private equity. For example, the government of Germany stepped in with an equity injection to save the airline Lufthansa. With falling valuations and low-interest rates, the current conditions present an attractive opportunity for private investors. However, being an active player during restructuring it will require the banking and capital markets industries to innovate and find new ways to reach deeper into severely affected sectors.
Answering the problems of smaller businesses
Financial institutions markets have previously created equity restructuring options, but they have never faced a problem on the scale of this crisis. This time necessitates the development of new asset classes capable of attracting capital while guaranteeing that the effect of that money is broad-based. Investors might, for example, take direct ownership shares in significant firms that provide liquidity to SMEs via trade credit. Alternatively, they might invest directly in exchange-traded funds geared for small and medium-sized businesses (ETFs). Furthermore, private investors and private equity companies might offer lower-risk funding for SMEs by taking minority holdings in enterprises, decreasing value sensitivity and ownership risk by keeping current shareholder control. The public sector can also make SME equity investments more appealing by modifying the tax treatment of returns or providing matching funds through business development initiatives.
Investors will need to provide the required short-term liquidity to lessen the crisis’s impact while realizing that equity returns may be a long game in all of these circumstances. Long-term pension funds and other long-term investment vehicles might be the “patient capital” required to support local community businesses. In addition, cross-sector groups could leverage community investment funds that offer industry expertise to make intelligent investment decisions. The alternative is a solipsistic and fragmented landscape of bankrupt businesses and shuttered communities.
“Banks want to fund and promote growth because we realize the obligation,” says Simi Siwisa, Head of Public Policy at Absa Group. “However, even some of our clients are saying the prognosis does not appear bright, and some will not invest until confidence returns.” You had COVID-19, you had the lockdowns, you had diminishing economic growth, a collapse in global commerce, a failure in trust, so who blinks first? Do banks provide credit? Or will the industry choose to reinvest? I believe there is a balance somewhere, and recognizing and locating it is critical.”
Assisting in developing markets
Bankers and financial market participants will also require a plan for emerging economies, where bankruptcy has traditionally been the sole option for restructuring. During the equity phase, investors will need to develop solutions and products that can help entire ailing sectors rather than simply individual firms, such as a quasi-equity fund that invests in smaller companies and is subject to fewer rules. Or mixed-finance solutions that provide much-needed financing without jeopardizing the banking sector’s stability and resiliency.
Such alternatives must balance the threat of economic nationalism with approaches to foster purpose-driven banking. Solutions for this industry might be similar to those for the SME sector, such as direct investing in ETFs or foreign corporate bonds. Firms might also take direct equity shares if they account for the potentially tricky regulatory environment.
The Banking and Financial Markets community cannot afford to sit out this one. According to Mensah, the anemic global growth of the previous two decades is a sign of developing market malaise. If the BRIC economies weaken, the US cannot expand at a 3-4 percent rate. The banking and capital markets industries have issued a call to action, requesting industry assistance for SMEs, developing markets, and ailing sectors through new, revised debt and equity strategies. In this manner, there will be clear-sighted yet broad-based economic support rather than merely giant firms and established markets weathering the storm and emerging victorious. It is still unclear if the credit crisis will escalate into a full-fledged solvency catastrophe for the banking industry. But we do know that the banking and capital markets industries have the potential to be game-changers in terms of how the globe may be restructured for development.
