Podcast transcript
Velvet-Belle Templeman
Welcome to Boardroom.Media. My name is Velvet-Belle Templeman, and I’m here talking to Paul Gooley, National Head of Corporate Finance at Grant Thornton, and Cyrus Church, Director of Neu Capital, a tech-enabled corporate finance firm specialising in private institutional debt and equity transactions. When times are tough, cash is king; but when the big banks start pulling back, where do you go for that all-important funding? Today, we’re talking about access to finance and alternative debt. With the financial crisis in 2008 taking nearly five years to recover, what types of finance can we expect from this COVID-induced recession? Will investors just go back to the normal big four financiers once all this is done and dusted? Thanks so much for joining us, Paul and Cyrus.
Cyrus Church
Thank you.
Paul Gooley
Thank you.
Velvet-Belle Templeman
We’re here talking about financing and alternative debt. Cyrus, tell me, why would anyone want to put their money into the market at a time like this?
Cyrus Church
Look, it’s a great question, and the simple answer is, people need to put their money somewhere, right? We’ve got this weird market circumstance where equity markets are trading at very, very high valuations, but the economic conditions are probably something that you can only describe as awful. Now, for people who want to take the safer option, and put the money in their bank, or buy government bonds, the returns they’re getting there now are negligible. You’re just getting a zero or even a negative return, if you take into consideration inflation. So you’re going backwards. So, the age-old adage of, “put your money under the bed is a waste”, well, the cash markets now, you’re basically putting your money under the bed, because you’re not going forward. Now, this has caused this rise of alternative asset classes, which is private equity, which is debt funds, which are offering a longer-term or through the cycle kind of yield, which is going to be above inflation. So we’re seeing that increased allocation from super funds towards these asset classes. So you’ve got these pools of major money, which is out there, who are looking for returns; which is good, because we need that liquidity right now.
Velvet-Belle Templeman
And from what I’ve seen, the banks aren’t really lending right now; so what are the options out there?
Paul Gooley
Well, the banks aren’t lending; they are extending credit, though, to their current clients. So there’s definitely been a fair bit of credit and liquidity by the banks to their current clients. But it’s fair to say if you’re a new credit for the bank, or an extension above your current facilities, the market is very tight; and we would expect that to continue, particularly if we go into a recession. If you’re in the public markets, there’s been significant secondary raisings in March, April, and May, as you would expect. That again will be avenues for public companies. But if you’re in the private markets, there is a whole range of different providers outside the banks, as Cyrus mentioned. There’s credit funds, hedge funds more at the institutional level; but also the family office and the high-net worth individuals, they do play in that alternative debt market, and more and more we’re seeing the neobanks, the fintechs, who have raised capital and are able to play in that alternative debt market, above where the traditional banks would play.
Cyrus Church
It’s a good point. I think there is still the perception in the Australian marketplace that if your bank says no, then that’s it, you’re out of options; which is definitely not the case. There are large pools of money out there, which operate in that hybrid space, that high-yield debt, or that debt plus a little bit of an equity kicker, which are available for mid-market Australian companies, particularly high-quality ones, to access. They can be a far more attractive option than raising further equity. A lot of companies just aren’t aware that that money is out there, so a big part of what we’ve been trying to do at Neu Capital is raise that awareness, that if your bank says no, and equity is not available, or you don’t want to go to it, that doesn’t mean you shouldn’t still pursue this opportunity. There is other forms of capital out there for you.
Velvet-Belle Templeman
What are you seeing in the marketplace, and from your clients?
Paul Gooley
It’s fair to say that we’re in a bit of a hiatus, at the moment. Clients have had a couple of different things; they’ve had a lot of stimulus from government, in many respects, through JobKeeper; they’ve had landlords providing moratoriums; the banks, as we said, have been providing moratoriums, at least for the June quarter, and probably for the September quarter as well. So, there’s been a lot of stimulus and support for clients, and a lot of them are just trying to hold until they see what does demand look like, coming out of the crisis. As I said, there has been a lot of secondary raisings, but in the private markets, private equity has obviously got a lot of capital; but again, they are looking for positive COVID opportunities, and so there hasn’t been a lot of deals done in that area.
So, at the moment, we’re just seeing really a bit of a holding pattern for most clients. I think everyone is trying to work out what does the new demand look like when we come out of this and we move into more of a traditional recessional period. Really, as I said, with all of those different stimuluses, the landlord support, but also very importantly the insolvency law moratoriums at the moment, we would expect that when they come off… Now, whether that’s the last quarter or the first quarter of next year, we would expect an increase in clients looking for liquidity, looking for other options, given that they’re going to need to resize their businesses. Some of them will come out quite strong into the demand they face, and they’ll need working capital facilities. So as Cyrus mentioned, there are opportunities to do that, because we do believe that the banks traditionally will come off a little bit and tighten their banking requirements, and will focus on their clients. So there will be requirements to fund working capital as we come out, and those alternative sources are going to be a key place for clients to go to.
Cyrus Church
I’d echo those comments. I think we are in a bit of a quiet before the storm, where everyone is just waiting to see what will happen, and the first movers will be those who have to do something, those who need the new money. I think as Paul mentioned, the banks are being supportive of clients, but it’s one thing to provide waivers of covenants, extensions on facility due dates; it’s another thing if they need more money, if it’s new money going in. That’s where I think banks will struggle, and that’s what will force outcomes in the short term. But right now, a lot of businesses are saying, “Well, if JobKeeper continues, our cash hole isn’t that great. If JobKeeper abruptly stops, our cash hole is going to be huge, and then we will need to do something.” I suppose the message we’ve been telling clients is you need to be having contingency plans in place for if there is just a sudden drop or if there is a recession. You need to have liquidity. It’s the people with the cash who will survive and thrive in the new world. It’s the people who find themselves with a very short runway, who need capital, who will be subject to predatory approaches by private equity, or very onerous terms from lenders.
Velvet-Belle Templeman
It sounds like we’re not seeing a lot of deals closing right now. What might be preventing some of the businesses from accessing capital?
Cyrus Church
From my perspective, I think it’s still valuation expectations. We had a period there where the ASX completely crashed in March. Now, that led to a series of secondary raises, and a very dramatic market recovery. So, some of the smarter companies have tapped those equity markets, and have sought to repair balance sheets. A lot of the other companies have said, “Well, we don’t want to do anything right now unless we have to, because we’re just not sure of what the future is being… Paul and I were walking on a sale process last year, and then COVID hit, and the value has halved, in terms of this vendor was looking at a price, and now the price has – on three different bidders – has gone down by 50 per cent, and that’s making them rethink the entire transaction. I think that’s a story which is playing out all over the market. People are a little bit reluctant to buy if there is a prolonged downturn, and earnings don’t come back; whereas vendors are still looking at what their earnings were last year and trying to value it off that. So, until we hit a stable ground, which I don’t think we’ll see until this government support comes off, it’s just going to be very hard to match vendor expectations and investor expectations, on the equity side. That’s why I think, as well, going back to those alternative debt spaces, those providers of funds in a debt capacity can be very useful in bridging that impasse.
Velvet-Belle Templeman
Is there anything we can learn from the GFC that might apply a lens to what’s happening now, and what will happen in the future?
Paul Gooley
Yeah, it’s a good question. I mean, the GFC was the last dislocation of financial markets. It was predominantly a financial liquidity crisis, rather than an economic crisis; although around the world, that followed, apart from Australia, where we didn’t go into a technical recession. But definitely what we saw out of the GFC was a tightening of liquidity from the traditional sources. If you look at it in both public and private markets, that took up to five years to come back from where it was before the GFC. Over that period after the GFC, the non-bank providers did capture some of that market share; but to be honest, back then, not a lot of them had the capacity to fund that, and also there wasn’t as much technology as the current providers have. They’re nimble, and they’re able to provide these sort of non-traditional banking and lending sources, where they weren’t probably in a position say, 10 years ago.
So we do think that the non-bank lenders will play a fairly large part in funding that hole that arises through liquidity; although as Cyrus mentioned, it will be a race to who’s got the best story, and who’s got the best business case and therefore we are encouraging people to get ready, and make sure you have a well-articulated story, particularly on what does it look like in the next couple of years as you come out of COVID, because there will be opportunities to fund across the market, and these providers will have the choice to be able to choose which credit they take. So being actually prepared for that, having a good story, and being able to work out where the market is going to level out for you and your business, and how you’re going to service the debt that you’re going to ask for, is very key in being able to access this funding.
Cyrus Church
Yeah, I think what we saw in the GFC… Funding costs spiked quite dramatically. There was just a… the cogs of credit slowed up. One thing we’re looking at quite closely is arrears and default rates across both the non-bank and bank lenders, because if that starts ticking up, and if unemployment does spike, and people stop paying back their debts, that’s what can really throw a spanner in the wheels of credit, and that can have a very serious flow-on effect, and it could turn out to be another full-blown GFC off the back of this. CBA released recently, one in eight of their mortgages applying for hardship provisions. Anecdotally, we had another customer which came across our desk, who is a provider of loans to small to medium businesses; the arrears rate there is tracking at 40 per cent, and that’s cafés, small business owners, who take 30,000 or 40,000-dollar loans. So that’s the kind of thing where it can really hurt, and can take a long time to recover, because if the banks do start having provisions shooting up, then the time it takes for them to go back to more normal lending levels will be extended, and that’s where it can take five years plus to come back.
In the GFC, I think also what we saw was, we were still doing restructures and work outs five years into the future. In 2013 we were still doing restructures of balance sheets which were broken from back in 2007, 2008. It’s just a lot of companies were in denial; they were still looking at the earnings from 2006 and saying, “Well, when it recovers to that, then our debt levels will be fine.” So I think we’re going to see a similar thing. I can see us still receiving earnings in 2023 which are still trying to normalise back to 2019 levels, to say, “We don’t have a problem here.” And it’s only until banks start taking enforcement action, or private equities start throwing the keys at lenders, that we’ll start to see that work its way through the system.
Paul Gooley
And as Cyrus mentioned, I think the difficult thing at the moment, and what’s really stopping transactions, is the ability to be able to forecast forward. We’re in this period where no one in this market has been in such a situation, where we’re coming out of something so dire, as a health crisis, and then we’re trying to work out wat is demand for your products going to be. That’s where I guess good forecasting comes into play, where you can sensitise downside scenarios, and you can work your way through and work out what is a likely outcome. Odds on, we won’t be able to work that out, maybe for a couple of quarters yet, until the market starts to recover from an economic perspective; but at least you can provide downside scenarios where the lenders can have a look at that, and go, “Okay, even in a downside scenario, if all these play out, then we can still service the debt. We can move it forward, and then trade out on the other side.” So getting prepared for that is crucial, because at the moment, it’s very difficult to predict, say, one month out, let alone three years out; and lenders need to have that review. They need to understand, “What’s my downside? What is the risk here of default, so that I can structure something that will get us through that period?” And having a good story, obviously, to come out of that period, and how you’re going to trade, and how you’re going to take advantage of the new paradigms that have arising through this crisis, whether it be work from home, or telehealth, and those sort of areas. How can your business take advantage of the new paradigm that’s come through work practises and where the demand is going to be, going forward.
Cyrus Church
And being in a financial position to take advantage of that. As I said, a lot of our smartest clients are getting their balance sheet in a position where they can take advantage of these changes, where they can gain dramatic market share. There will be opportunities which fall out of this, where people need to do a transaction in order to dig their way out of a hole, just because they’re still sitting in debt, and they’re still waiting for the return of 2019 earnings; which is a horrible way to be. You need to be planning for if there is an extended down period, having enough cash and liquidity to take advantage of that market circumstance. There are people out there who have available liquidity to put you in that position.
Velvet-Belle Templeman
So, alternative debt, private equity – is this something that will be around for a while, or when things recover, will people go straight back to the banks?
Cyrus Church
The banks will always be the cheapest source of funding; but in these market circumstances, banks will go risk-off, and they will not push the envelope. So the amount of capital that banks will make available to you will become less and less. So in terms of the overall funding pie that you need to solve for, banks will always be a part of that; but I think increasingly, as banks go, “We need to preserve our balance sheet, we need to go risk-off”, the loan to value ratio that they’re willing to do, or the multiple of cashflow earnings that they’re willing to do, particularly as to Paul’s point, given forecasts are now very fudgy, you can’t really have a concrete forecast in the current environment. So their willingness to do aggressive cashflow lending will disappear.
So for the next three years, even five years, I can definitely see these alternative funders playing a critical role for companies who have a high conviction, and who have investment opportunities which are going to add value to their shareholders. And they’re a lot more flexible than a bank; so whilst a bank is cheaper, I think a lot of these alternatives will be able to have a deeper understanding of the company, will be able to be flexible in terms of the cash requirements that they have. They can take non-cash components, they can take equity upside, they can really sit down and have an intelligent conversation with a company about what they actually need, and structure something which will work for them; as opposed to the banks, which you’ll see more and more, it will be, “Well, we only lend 50% LVR, and the computer said no. That’s our new lending policy”, and it will come down from on high. Their ability to be flexible, to be client-driven, will become less and less. They’ll probably retreat back, and that’s certainly what we saw in European banks post-GFC. They retreat back to their core personal banking; residential mortgages, credit cards, those type of products. Or lending, if there’s residential property supporting it; not your aggressive private equity, sponsor-led transactions, and certainly not acquisition finance at any sort of meaningful level. So yes, I can see alternative debt, and particularly going back to the first point that we raised, that there is a wave of alternative debt available now, as well, as superannuation funds seek returns which are in that high single digits, outside of market volatility. There’s a wave of money available to it, but as banks withdraw, it’s going to be a key part of the capital structure for at least the next five years.
Paul Gooley
I would agree with that. Just some clarification, I guess, from the banks’ perspective; what we saw after the GFC which was different to before the GFC, was how much the banks supported their client base. As Cyrus mentioned earlier on, we would definitely expect the banks to support their client base. That will in certain circumstances mean increases in credit limits, for certain circumstances, and they may have more assets to cover that coverage; but we don’t foresee anywhere where the banks are going to go aggressive on their client base. I think they’re going to go deeper on their clients, particularly the ones they know. They’re going to keep their lines in place. As Cyrus mentioned, what we saw is that they will work out these issues over an extended period of time, so three to five years; but whilst they’re focused on that, that’s where it makes it very difficult to write new credit. The other thing that will happen, I guess, as time progresses, is that they’ll take a sector-by-sector base approach to new credit, and they tend to have sectors where they will like to lend into, and sectors where they probably won’t lend for a while. That may change over time. Again, there will be credit available, but I think it’s safe to say that traditionally, they will tighten the standards for a period of time, and they will focus on maintaining their relationships with their current clients, helping them to get through this period. In relation to private equity, these are always opportunities for private equity to have what they would call a good vintage deal, which is a deal where valuations are slightly lower than usual, and they can then grow that business by two to three times over the next three to five years, to make some good returns.
So there’s definitely a lot of available capital as well, with these private equity firms. At the moment, they are really looking at some of the theses coming out of the crisis, whether it’s IT-enabled businesses in healthcare, in business services, outsourcing, et cetera; and we would expect that to continue on, and as the market develops, and as we get more vision of what the new demand levels look like, I think they will broaden that. But definitely we’ll be focused on businesses that are going to be positive to COVID, or at least protected from COVID, coming out of this, and have opportunities to take advantage of the new ways we work, the new ways people buy things, et cetera. The new macro shifts that we’ve seen will probably be around for at least, you know, an extended period of time; and businesses that are well placed to take advantage of that will attract private equity, and will be able to make good returns going forward. So it is going to be an interesting period. I guess the overarching theme here is that these things don’t resolve themselves in a V-shaped recovery that some commentators would suggest. These things usually take time to work through the system, and given the depth of this potential recession coming, you would expect this to be an extended return to liquidity over a three-to-five-year period.
Velvet-Belle Templeman
Paul and Cyrus, thank you for your time.
Paul Gooley
Thank you, Velvet.
Cyrus Church
Thanks, Velvet.
Velvet-Belle Templeman
You can find further information on how COVID-19 might affect your business, and assistance is available to you on the Grant Thornton COVID-19 hub at www.grantthornton.com.au/covid19. My name is Velvet-Belle Templeman, and you’re listening to Boardroom.Media.
