Financier John Dennis says the success of the new 30 per cent Capital Allowance depends on funding availability, but as banks exit the market, or tighten down the hatches, accessing the moolah needed to buy the kit may prove difficult
Will the 30 per cent capital allowance stimulate the economy? The short answer is no, a tax incentive in itself is insufficient to stimulate capital investment - if tight credit and liquidity limits the ability to fund the investment in the first place. Unfortunately, this issue has not yet been addressed by the Federal Government at all.In 2008 we saw the availability of credit contract sharply in Australia due to the global banking crisis – in short, tight liquidity in global debt markets saw a sharp contraction in the availability of funds available for lending.
In 2009 debt market dynamics are shaping up to be a continuation of tight liquidity however the contraction in the availability of debt will be much more severe despite government intervention as delinquencies rise, bad debts materialise, asset values continue to fall and local banks with balance sheet capacity are forced to bail out their departing international banking partners in syndicated debt/ senior debt facilities rather than build new banking relationships.
There will be no short term recovery in the banking sector and as a consequence, no relaxing of the credit and liquidity constraints we are now seeing. Indeed both will get significantly tighter during the next 12 months.
Realistically, many of the banks and financiers now exiting Australia have spent decades and billions of dollars building their operations here – they aren’t leaving for a holiday – they’re gone for good – changing the fundamentals of the Australian banking and debt markets for the foreseeable future.
Borrowers and market participants that don’t react and respond to this paradigm shift in the domestic credit markets are likely to share the fate of a growing number of high profile companies in financial distress and the availability of equity funds as an alternative to debt will evaporate as maintainable earnings fall, dividend yields collapse and investor appetite wanes.
Credit markets are getting tighter by the week and in many cases despite having fundamentally sound businesses with substantial underlying net operating cash-flow, the larger you are, the harder it is going to get!
Just about every bank remaining in the Australian domestic market has capacity and exposure issues against the majority of our largest local and international companies – forcing these companies to consider raising equity despite unfavourable investment conditions.
With almost all of the international Banks lending to your industry sector seeking to exit there is little real likelihood the remaining players will have the appetite and balance sheet capacity to absorb their exposures on top of their own existing ones.
Large slabs of corporate debt are quietly trading at significant discounts. In simple terms, senior debt deals negotiated and written 18 months ago at sub 50 basis point margins and minimal up front or ongoing fees are being offered at 250-400 point margins (by discounting their face values) by banks seeking to either exit or significantly reduce their exposure to the local market.
The syndicated debt desks of most major banks now have to contend with many of their international co-investors actively seeking to trigger review events that will enable repricing or an early exit of facilities priced and committed to before the credit market collapse.
There has been a global paradigm shift – credit was once a commodity where excess supply made it freely available to anyone on terms that clearly could not be sustained and most economic commentators from Presidents and Prime Ministers down are now talking of a credit recovery taking several years.
Before considering a new transaction, bankers in the Institutional and Corporate space now have to justify their participation in light of existing client and sector exposures; their own balance sheet and tax allocation (if a lease) and the sector outlook in terms of asset values and security (as well as client relationship; credit strength; past and future relationship; product cross selling opportunities, etc)
Let’s face it, if a Bank has exposure to a senior debt facility where the participants are no longer harmonious due to Country exit strategies (rather than underlying credit concerns, ) they are more likely to take out their partners at a discount to avoid putting the underlying client at risk than consider an entirely new exposure or support new CAPEX.
And banks now demand recognition for their support. The days where a bank would underwrite a larger facility than they could hold directly and risk a future sell- down to other, secondary participants on an uncommitted basis is well over. Deals are only being written where the lead manager has already obtained formal commitment from additional lenders up front and few banks are now willing to take a piece of a transaction in a secondary or unrecognised role for another lender in this market where relationship and kudos is so important.
And now these exposure issues limiting credit appetite are moving down into the Commercial and business banking space. It’s also payback time (although no bank will ever admit it).
For years Treasurers and CFO’s of major corporates have dictated terms to a banking sector flush with cash and with big lending appetites. Debt was a commodity where supply exceeded demand. The degree of arrogance exhibited by these corporate executives put Wall Street bankers to shame at times however (though you may never have guessed it) most senior bankers with balance sheet capacity have big egos too.
That said, those same bankers in the Corporate and Institutional space are now watching their competitors close, and their own institutions shed staff and reduce capital available for lending – electing instead to pick up discounted debt from banks fleeing our market or allocating more capital to their retail and business bank areas where ROI/ ROE has historically been much higher with fewer net losses.
Accordingly qualitative as well as quantitative factors are now impacting lending decisions in a market where cash is no longer a commodity being offered at the lowest price available.
Forget tax incentives, just maintaining liquidity and borrowing capacity over the next year or two and the availability of debt on competitive terms will become a critical challenge for most CFO’s and Boards. The key will be to have secondary lines of credit available in case issues arise with your primary bank or syndicate.
Borrow
So how does an organisation looking to borrow without compromising its primary banking relationship counter these changes?
Firstly, establish relationships with reputable, experienced, long standing firms and individuals with the expertise to structure and package your funding requirements and offering some certainty of remaining in the market to manage and oversee your funding structures for the duration of your funding term.
In equipment finance, the best place to start your research is the Australian Equipment Lessors Association (AELA) at www.aela.asn.au
AELA is the banking industry body representing all major financiers engaged in underwriting asset/ equipment finance within the Australian market. Membership is available only to major financiers, managers, packagers and banks together with the most reputable industry advisors from the IT, legal, HR and accounting professions involved directly in the equipment finance industry.
Some States have competing local finance broker/ lease broker bodies that serve a purpose at the retail and commercial end of the market however AELA represents the higher level lenders and professional advisors participating in this specialised market. It’s also likely a large number of finance brokers will disappear during 2009 as market conditions tighten and lenders dealing through intermediaries become scarcer.
Secondly, make sure the relationships you seek to build are with individuals and firms likely to be around for the long term. Sadly, just about everyone in banking and finance from board members down are vulnerable to retrenchment in the prevailing market. The only likely exceptions are those with certainty of tenure within AELA such as executives in long standing, financially secure large ticket lease packaging firms (a blatant plug – I know).
These specialist firms are extremely useful as they keep very close to all participants in the financial services sector (both those coming into the market and planning to leave it); are generally aware of staff changes within the banks as soon as they become public (and more often than not before they are announced); remain in tune with client and sector capacity issues facing most Banks and underwriters and can develop and establish funding lines without compromising existing banking relationships.
Finally, ensure you have a number of lines available. Circumstances change and market appetite for your credit can change overnight – the last 12 months have clearly demonstrated this where borrowers have suddenly found themselves without the financial support of their long term bankers because of an industry exposure issue (rather than anything specific to their own relationship) or a directive to withdraw from an industry sector, market or country.
Drawing down against stand alone equipment finance lines in order to maintain/ preserve available liquidity provides an effective counter measure to a tightening credit market.
In contrast, relying on your ability to raise fresh equity when domestic and overseas share markets can swing by 5-10 per cent or more in any given week may not be prudent in the prevailing market.
So…. the new Capital Allowance tax break will be great for those with ongoing profitability and plenty of cash but….access to cash in the form of equipment finance is a far more critical issue facing the market.
About the author
John Dennis is the managing director of Australian Structured Finance – a leading independent large ticket Leveraged and Equity lease packaging group in Australia for more than 25 years. He is a long term Council member and past Chairman of the Australian Equipment Lessors Association [www.structuredfinance.com.au]
