Deals into the light; lending into the shadows

Takeaways: Greece is taking this to the 11th hour, so we turn our attention to buying and lending. Global M&A is still going great guns despite the slowdown in Q1…or is that because of? Meanwhile, more data on shadow banking pushes it out into the light and further to the notice of regulators. But there’s also pressure to open up the market as it increasingly becomes a vital source of funding

 Greece…what else…

As we publish, the deal is still on the table, Greece has deferred payment until the end of the month and markets aren’t quite sure what to do while they wait. Mario Draghi said in the ECB conference this week that investors should ‘get used to’ bond market volatility…like 10 year Bunds going to 1% and down to 0.85% on Thursday?

The history of this crisis tells us that there will be a deal…recent history suggests it might not be durable.

What’s driving M&A?

May was an exceptional month for M&A and those ‘megadeals’ just keep rolling in.  There were seven deals over US$10b announced in May 2015, taking the total for 2015 well beyond the YTD  totals of 22 in 2006 and 2007. Of the 27 announced so far this year, over a quarter have been in healthcare, but activity has been broadly spread overall. By geography, the focus is firmly on the US, with 17 deals against Western Europe’s four.

 How do we square this rise in activity – across the whole M&A spectrum – with the US and global Q1 slowdown and the rather underwhelming data thus far in Q2? JP Morgan estimate that annualised GDP growth was just 1.2% in the first quarter, down from over 3% in 2014. This week the OECD cut its 2015 growth forecast to 3.1% from the 3.7% it was forecasting last November.  Of course, companies aren’t just buying companies for Christmas – as it were. These large acquisitions are part of long term strategies. Indeed, a few have been muted or even attempted before, but without the means and the market backing that is there today. Growth might be disappointing in 2015, but equity markets haven’t got the memo. They are still hovering around record highs, either banking on Q1 being an aberration – or offering a promise of “looser for longer” monetary policies. By the same token, for all the recent volatility in debt markets, finance is still available and cheap.

The prospect of more difficult markets can also provide deal motivation. Oil mergers rose in the 1990s when crude prices fell and companies looked to cut costs –as they are again now. Consolidation themes run across recent M&A activity, epitomised this week by the bid for Findus’ European operations by the investors behind Birds Eye, to create a fish finger colossus. There are plenty of other recent examples, from Heinz and Kraft to Syngenta and Monsanto – although, it would be wrong to pigeonhole these and other deals. There are many interlinked strands crisscrossing deal activity. Disruptive influences came out very strongly in our most recent Capital Confidence Barometer, with three-quarters of deals motivated by the need to reshape the core. Economic divergence overlays all of this, opening up opportunities for companies to borrow cheaply and buy growth in other areas – particularly the Eurozone, although recent US weakness could lessen the currency advantage.

 So will M&A continue at this level? To answer this question, we can’t ignore the growth question indefinitely. Equity markets will struggle to maintain their poise at on QE fuel alone. Valuations will start to look more stretched if global activity doesn’t pick up. The question as to whether recent growth jitters are an aberration or part of a longer term trend takes us into the heart of the biggest current debate in macroeconomics. Are we in the midst of a longer period of stagnation, with origins that pre-date the crisis, or will deleveraging pull us out of this trough?

 It’s a heavyweight debate, with such contenders as Larry “Stagnation” Summers  and Ben “The Deleverager” Bernanke. Unsurprisingly there was no consensus at the IMF’s recent Rethinking Macro Policy conference. Economics is the only subject in which two people can share a Nobel Prize for saying opposite things. However, the IMF’s chief economist – and for the most part bond markets – seems to be erring slightly more towards the long-term difficult growth, lower interest rate side. Citi’s Willem Buiter has also added his weight this week.

 It’s also worth thinking more broadly about how growth, and disruption challenges might affect competition issues, which have stymied a number of deals recently. These failed deals have raised concerns that in a bid to retain competition within their own geographies, EU and US antitrust regulators may be limiting companies’ ability to compete in the global market place. It will be interesting to see how companies react and adapt themselves in choosing targets, but also if regulators adapt to the changing growth and disruptions to sector landscapes.

 Long shadows

Data from the US this week shows non-bank lenders capturing over 50% of government-backed mortgages, almost doubling their share from April 2013. Another data point in the inexorable rise in shadow banking – an amorphous term used to cover just about everything that looks like a bank, lends like a bank but isn’t treated by regulators as a bank because it isn’t funded by retail deposits.

The latest global figures available from 2013 show global shadow banking assets of $75t and approaching 2007 levels in terms of percentage of GDP. Given the phenomenal increase in activity of late, the current size of the market is likely to be well past pre-crisis highs. Although, it seems somewhat disingenuous to compare, since its shape is vastly different. The most notorious versions of shadow banking – off-balance-sheet vehicles – have now been pretty much regulated out. Regulators have effectively nudged or pushed (depending on your perspective) all manner of riskier lending away from banks. All of which and more has been picked up by a vast array of other providers, from money market funds to finance companies, real estate investment trusts and online peer-to-peer lenders.

It begs the question, where would the recovery be without them? And, whilst there are increasing calls for regulation, there is also an acceptance that shadow banks are now a vital part of the lending environment. This raises difficult questions and inevitable lobbing for not more, but less control. For example in the US, where there are attempts to provide tax breaks and looser leverage regulation for Business Development Companies (BDCs). The growth of the BDC loan market – tripling in the last three years – has attracted banks, also blurring the lines.  Goldman Sachs, Credit Suisse and Morgan Stanley have all recently launched their own BDCs.

 Inexorably we also now have calls for a loosening of bank regulation, to allow traditional lenders to compete. Recent research from Goldman predicted that  non-traditional lenders could eat into $11b worth of the $150b in annual profits across the US banking system in coming years.

And whilst this goes on, global debt has grown by $57t and no major economy has decreased its debt-to-GDP ratio since 2007. History doesn’t always repeat, but occasionally it rhymes.

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