Panelists At BoyarMiller Capital Markets Forum Predict Continued Economic Challenges With Few Bright Spots
Housing Market, Unemployment, Financial Reform Act and Lack of Credit to Blame
HOUSTON, Texas (September 14, 2010) — With continuing forecasts of a double-dip recession, a faltering housing market and a 12-month unemployment rate fluctuating between 9 and 10 percent, it is no wonder that panelists at BoyarMiller’s annual “Current State of the Capital Markets” forum were cautiously optimistic about what the future holds for economic recovery in the U.S.
Held at The Houstonian Hotel in Houston, the program featured: Steve Stephens, president of Amegy Bank of Texas; David W. Sargent, president and CEO of Growth Capital Partners; Andrew D. Kanaly, chairman and CEO of Kanaly Trust; and Thomas J. Melody, executive managing director/co-head capital markets group of Jones Lang LaSalle.
While each presenter discussed details within their respective industries, deleveraging was the theme across the panel. “We will look back and call this the great era of deleveraging,” Stephens said.
Americans are getting rid of debt or bad assets and storing cash. With this trend comes hard times for banks as consumers and businesses are not buying on credit; thus, banks are under increased pressure to find revenue elsewhere. As explained by Sargent, “U.S. household debt as a percent of disposable income has doubled since the early 1980’s, with debt making up 133 percent of disposable income at the end of 2007. What’s more, it takes longer to get out of debt than the reverse, and with nearly two years since the economic collapse, it is no wonder that deleveraging is still in process.”
Since deleveraging is occurring, naturally there is a stockpile of cash on hand, the panelists concurred. Although banks have cash to loan, lending is still challenging as “more restrictive underwriting tests to prove cash flow capacity has tempered banks’ enthusiasm to loan money,” explained Stephens. In addition, the proliferation of institutional private equity funds has continued to create a significant buildup of un-invested capital as a result of record fund raising in 2007 and 2008 before the meltdown and with suppressed deal activity since late 2008. In fact, it is estimated that $400 billion is committed but not invested. Thus, it could take nearly 11 years to invest the private equity overhang because most private equity capital has a 5-year investment period, meaning that the capital must be invested faster than in 2009 or the funds will have to be returned to investors.
Couple the overhang with the challenging bank lending environment and you have investors who are seeking more creative ways to deploy capital. One capital investment strategy that seems to be growing is smaller transactions, with M&A activity for the lower middle-market jumping up 59 percent from a year ago as small deals are easier to finance. In fact, deals of $50 million and below were up more than 20 percent in early 2010. The first half of 2010 saw strong M&A activity, with the number of transactions up 44 percent from the corresponding period last year. According to Sargent, M&A activity over the next six to 12 months is expected to be positive due to the following:
- Resurgence in financial sponsor activity (to avoid return of un-invested funds)
- Corporations seeking growth through acquisitions to offset slow organic growth
- Corporations have record amounts of cash on hand
- Increasing Debt/EBITDA multiples
While banks have cash on hand and are trying to lend money, regulatory oversight is a hindrance to growth in this area. Stephens explained “bank credit is contracting at an unprecedented rate of 15 percent annually as lenders sit on a record $1.3 trillion in cash.” Taking this one step further, Melody explained that “distressed property levels are high and banks are working hard to restructure or modify loans so they do not have to foreclose. With this, there is $1.5 trillion in debt maturing in the next three years, $1 trillion of which belongs to banks. What has to happen? According to Melody, “there will be no other option than foreclosure or loan restructuring/ modification for many loans. Banks won’t sell their charge-offs until they have accumulated enough reserves to withstand the losses they will incur and stop ‘extending and pretending’.”
Unemployment concerns still linger among the panelists, with unemployment claim statistics continuously dropping then rising. On September 9, the U.S. Department of Labor reported first-time claims for unemployment benefits fell to the lowest level in two months; however, in the last month, the unemployment rate rose again. As Kanaly pointed out to the crowd of nearly 250 guests, “unemployment claims are typically a lagging indicator of economic recovery and, in past recessions, stocks did not sustain a recovery until employment stabilized.” Sargent agrees that high employment claims may last for several years.
Specific to the real estate industry, Stephens says “real estate exposure is the biggest concern in banks, though it is now better contained.” In fact, Kanaly stated that “the housing market is not out of the woods, yet.” He anticipates monthly resets on troubled mortgages to pressure the residential housing industry for two more years. There has been a sharp decline in new and existing home sales since the Homebuyer Tax Credit ended. Similarly, commercial real estate transaction volumes were down 89 percent in 2009 from its peak, with volumes through the first half of 2010 well ahead of the 2009 pace.
Stephens concluded by stating “unlike the 1980s, Houston is relatively well-positioned to withstand economic stress. Two of the primary reasons are a quicker rebound of energy prices in this cycle and a faster and more successful response by the business community to changing conditions.”
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