Capital Markets Experts Convey Cautious Optimism at BoyarMiller Forum
While interest rates tighten, commercial lending and private equities remain strong
HOUSTON (Sept. 15, 2014) – Tightening of interest rates, strong commercial lending activity and a solid private equity market were key topics presented by experts at the annual “Current State of the Capital Markets” forum hosted annually by BoyarMiller, a Houston-based business and litigation law firm.
Bill Boyar, founding shareholder at BoyarMiller, asserted the question on everyone’s mind in the opening remarks: “It’s a great time to be in Houston, and everyone wants to know how long this is going to last.” Insights from presenters revealed optimistic overtones for capital markets. There was a sprinkling of caution regarding equities and the impact of banking regulations, and a positive report on exponential growth in private equity funds.
Expert panelists included Rusty Guinn, deputy chief investment officer for Salient Partners; Paul B. Murphy, Jr., CEO and president of Cadence Bancorp; and Cliff Atherton, Ph.D., managing director with GulfStar Group.
More than just interest rates
“We think the expected rise in interest rates is being priced into the market already,” said Guinn. He added that a bearish view on bonds means investors are betting on not just a rise, but a surprising rise. Guinn also went on to discuss the importance of interest rate views on the construction of investment portfolios.
“I think this is more important than just betting on the direction of interest rates, especially when building portfolios,” said Guinn. “We don’t believe in crystal balls, and we don’t believe you have to be able to predict where the market is going to be a successful investor. But we do believe that most investors are generally far too heavily positioned in equity markets.”
According to Guinn, in a traditional 60/40 balanced portfolio, more than 90 percent of the risk is driven by an investor’s allocation to equities. If an investor has a strong rising interest rate view, that investor should consider whether to increase exposure to inflation-sensitive assets, rather than reducing exposure to treasury bonds.
Guinn said the stock market has already achieved most of the gains Salient anticipated for the year. The sectors that are performing best are healthcare, energy and utilities. The stocks that are performing poorly are those in more consumer-sensitive areas of the economy.
“The stock market is up a fair amount, but underneath the market, it’s the lower-risk stocks that are doing well,” said Guinn. “The truth is that it’s the stocks in the middle that are doing most poorly. The highest-beta, highest-risk stocks and the lowest-beta, lowest-risk stocks are the ones that are outperforming.” He went on to discuss the push-and-pull between bearish fundamental investors and more bullish macro investors who closely follow central bank actions and market trends.
Guinn summed up his position on equities with a note of caution. “We don’t have a negative view by any means, but we are cautious about the potential for volatility to creep back into the market” if investors on either the central bank narrative or fundamental side of the debate begin to shift their views.
Bank regulations provide costly protection
Paul Murphy of Cadence Bancorp provided an overview of banking regulations and the outlook for commercial and industrial lending. He agrees with the need to protect consumers and prevent money laundering. However, at Cadence, the cost of complying with the Dodd Frank Reform and Bank Secrecy Act is more than $3 million with 27 persons dedicated to regulatory compliance.
“The increased regulation hits smaller banks very hard and drives mergers and acquisitions in the financial sector,” said Murphy. “You can probably expect more because 33 percent of Dodd Frank is still not implemented.”
According to Murphy, global inflation is in check. He said what would really drive global inflation to increase would be labor, primarily, and with the globalization of markets labor is abundant. He believes the core drivers of inflation look to be very subdued.
Additionally, Murphy said there is a good chance that the Fed and other central banks around the world will have engineered a soft landing for our economy. He serves as Houston branch director of the Dallas Federal Reserve Bank and has confidence in its ability to study the economic issues and make good decisions.
Shale plays continue to drive middle market commercial and industrial companies and their lenders, said Murphy. “Looking around Houston, it has never been this good for this long. And while that may make some of you nervous, I’m actually optimistic.”
Murphy cited companies benefitting from increased capital expenditure along the Gulf Coast in the next 10 years. In the Houston Ship Channel, 125 projects have been announced with investments estimated at $84 billion.
Regarding financing, Murphy said people are putting more equity into commercial real estate deals than ever before. Many experienced developers, private equity firms and investment banking firms choose to be over-equitized. “There is fierce competition among banks for these deals,” said Murphy. “It’s a great time to borrow money.”
Developers are offering more equity in projects. Murphy said it is a mind shift from the 1980s when the mentality was to borrow the most. Now, developers have the money they want to put to work, and it offers them a better rate.
Equity is also driving the multi-family market with developers being conservative to assure that new units are being absorbed. Murphy said it is the same for the office market, where 67 percent of space is pre-leased and industrial real estate is being absorbed with rent’s increasing.
“It’s hard to look around today and not be optimistic, but I’m not saying things can’t turn down,” said Murphy. “For now, it makes me comfortable.”
Robust private equity market
Cliff Atherton of GulfStar Group reviewed the private equity market where $3.7 trillion has moved into private equity marketplace worldwide representing incredible growth for an industry that began in the 1990s.
Atherton said that valuations are continuing to trend upward with the strong private equity marketplace. Multiples are very high, and Atherton is seeing oilfield service companies trading five to six times. “Absent a technological or other significant market advantage, it is difficult to get more than that for a private company,” he said.
Because it’s a relatively young marketplace, one of the things to track is the flow of liquidity into these middle market companies, which Atherton describes as absolutely critical. GulfStar tracks not only how much money flows in, but how much capital is being deployed and how much is available.
Atherton is bullish on Houston and Texas stating that the underlying economy is still very strong. “If you look at the drilling budgets and the wells being planned to fully develop these resources, it is just phenomenal.”
He said the private equity market is very robust and there is incredible exponential growth in the number of private equity funds out there.
“Even if the tax laws change, there is still a real need on the part of the investors to have the opportunity to invest through private equity,” said Atherton. “But the quick takeaway – there’s still plenty of capital coming into the private equity marketplace to fund deals.”