The latest Federal Reserve speak provided some input into just when the Fed will start to raise rates and by how much.
Not every sector is awash in cash. I was surprised to see an article that liquidity for secondary bonds is drying up. “On Wednesday, the Bank for International Settlements became the latest major authority to sound the alarm, warning that it is becoming harder to trade in bond markets and that the problem could spill over into the real economy. Those comments echo concerns recently aired by the Bank of England, as well as the views of a slew of major bond-market investors and analysts.”
The quotes in the WSJ from bond traders reflects a market concerned about over leveraged deals, interest rates, and where the market is going. It also indicated new issues had no such issues.
Personally our Weston Delray PE firm looked at a high profile company that is highly leveraged and facing chapter 11. The bond holders are owed $300,000,000 and a new secured loan is on the books at $100,000,000. The company has a negative net worth and losing money and market share. The bonds could be worthless and the $100,000,000 loan may end up being under water relative to FMV. We shall see. What are these bonds worth in your eyes. Yes, this is a very negative situation but what percentage of the over leveraged deals does this represent. The numbers are large.
Liquidity – New Regulations on LBOs. (Possible decline in Valuations)
The government was concerned with the highly leveraged deals with debt multiples in excess of 6x of EBITDA. This resulted in strong suggestions to bankers that they reduce the amount of debt available for LBOs. This has caused a substantial decline in PE deals and the multiples they can pay. This may ultimately decrease the value of your client’s enterprise. Leveraged deals are down from 35% to 21% that exceed government regulations.
This has impacted loan volume for leveraged deals,” an 82% decline over the same period in 2014 and the lowest level since 2009, according to Dealogic”.
If PE firms are forced to change their investment model it will impair results for investors. Ultimately if PE firms start to pay smaller EBITDA multiples for deals it will flow into the general market and reduce the multiples on smaller middle market deals.
MS Gilmore provided some guidance on the first quarters GDP. She would not be surprised to see a small negative growth number for the first quarter. Today’s information that orders for nondefense capital goods excluding aircraft, dropped 1.4% from January for the sixth straight decline.
Recent economic data has shown similar signs of weakness tied to weather. U.S. retail sales fell 0.6% in February, the third consecutive monthly decline. It also reported a 17% tumble in housing starts in February. Housing starts are not a long term concern if one thinks about 8 ft. of snow on the ground in the Northeast.
She referred to the weather as an issue and expected GDP to rebound in the second quarter and that by year end the positive GDP will be in excess of 2%.
There was some discussion at the presentation regarding Oil rig investment and its impact on data. MS Gilmore indicated oil related capital investment was a very small percentage of global consumption.
Interest Rate Forecast
The Fed governors have lowered their estimates of how high rates will go. At one time they were looking at rates = 3.125 by the end of 2017.
I came away from the Gilmore presentation with the distinct impression that rates will rise as GDP moves forward. Inflation is of major concern to all but with the dollar so strong and getting stronger, well maybe, is it possible to see inflation. I have started to look at upgrading my road bike and visited a large retailer for a composite road bike. After getting lots of information is struck me that the price tag will decrease by 20% the next time orders are sent overseas. Can I buy the bike for 20% less soon?
So instead of looking at retail sales should we start to look at units sold.
All I can say I that the graph on future interest rates presented at Gilmore’s presentation was not flat but had a fairly step (think intermediate ski slope) to it. She only mentioned a possible initial rate increase with the balance dependent on the economy. If those GDP numbers start to rise over 2% I would think rate increases might resemble GDP increases above 2%.
As for inflation and other trends time will tell. As a friend and senior Fed economist stated the market is just not reacting how you would expect. It is like opposite what you should expect.