Debt Capital Markets: A Panel of Experts Looks Ahead [Video]
2020 has been one of mixed fortunes as some segments of the debt capital markets (DCM) showed resilience in a tough environment while others struggled to remain afloat. What lies ahead for DCM in 2021?
4 March 2021
Debt investors see a path to recovery after navigating a difficult economic environment in 2020. I participated in a panel discussion, “What Lies Ahead for Debt Capital Markets in 2021?” The panel included Laughren Group and SBP Management, who shared their views on the outlook for 2021, including risk factors, changes to asset allocation, the due diligence process, the macro landscape and the preference for domestic versus global markets. Here are six key takeaways, listed in no particular order:
In the debt markets, risk is greatly rewarded. Brandon Laughren, CIO of Laughren Group, sees robust opportunities in private debt, as the public side has benefited from central banks flooding it with liquidity, shielding it from dislocations that could cause future economic pain. Michael Danov, president of SBP Management, is particularly drawn to distressed energy and metals and mining, where convertible debt can be sold into the equity market, preserving liquidity and possibly collecting dividends. He looks for companies exhibiting a healthy balance sheet, demonstrating they can repay debt in two to three years. I shared that there appears to be optimism in CMBS versus commercial real estate in 2021. Coming off a strong 2019, CMBS struggled in 2020, but began to rebound as companies scrambled to raise liquidity.
Biden administration policies could warrant shifts in investment strategy. “Rising commodity prices such as an increase in gold will affect the metals and mining industry, for example,” notes Danov. He also recognizes that corporate tax policy may not be as favorable going forward as it was under the previous administration, and investors must plan accordingly. I shared that the Fed’s quantitative easing (QE) program, interest rates and inflation will be factors to watch.
Mitigating risk is a dominant theme. Low interest rates can help temper risks. Danov believes that borrowing to fund real estate rather than accessing the equity market may be more attractive now that U.S. interest rates are at the two percent level. “However, should rates rise, or we see floating rates, it would signal a move toward equity,” he says. Brandon Laughren maintains that applying solid metrics for manager selection is a strong risk-mitigation tool, and he invests only with managers who have at least 25 years’ experience in the asset class aligned with their geographical and industry expertise. He further differentiates between managers operating in a core function of the economy versus more peripheral areas, and he is laser-focused on the potential for fraud. “Fraud is the one thing that can keep you up at night. A manager can diligence well but not end up owning what they say they own.”
Investors are making some changes to their asset allocation in 2021. Brandon Laughren worked closely with managers in the early stages of the pandemic, triaging portfolios to understand their exposures and ensure adequate bank lines were in place and that managers were realistic and proactive about the potential economic effects. He has made small allocations to liquidity for general partner (GP) funds but is remaining largely circumspect until the final results of 2020 are evident. Danov is considering investments in factoring and revenue sharing for consumer products companies, making sure they offer adequate downside protection, have experienced management and demonstrate the ability to exit within 6 to 12 months. Based on conversations with my clients, there could be a renewed interest in leveraged loans, as M&A begins to strengthen, though real estate will be slower to come back.
U.S. investments represent more attractive opportunities than international markets. For one thing, the U.S.’s legal system offers an additional layer of protection. “I can always go through liquidation or bankruptcy to protect my interests, because there are laws and a system that works well. That is not necessarily so in the rest of the countries, unless you have local partners, local opportunities and local managers where you source that you can rely on,” says Danov. “But investments must be priced appropriately,” Laughren adds. “Most emerging markets aren’t worth the currency risk for the same return that is available in the U.S.” Michael concurs. “If a 12 percent return is available in the U.S., why would I go to Europe for 13 percent? But, if I could achieve a 20 to 25 percent return in emerging markets through an equity conversion in an area where we have a footprint, I would consider it, but I would start small,” he explains.
Investors remain committed to stringent due diligence. Danov stresses that management is the key component, and he then drills down to the underlying industry, balance sheet, team and strategic partnerships. He examines the financing structure, including ratchet protections, covenants and resets, assessing the potential yield versus what is available in the U.S., and then evaluates the risk. Laughren adheres to focusing on manager attributes. “Due diligence is very much about the relationship, building trust, building credibility. If we’ve had a good experience, and the manager can give a compelling argument about why this opportunity stays within their skillset and provides good investment opportunity, then we are comfortable moving forward with the investment.”
Debt capital markets are emerging from a difficult struggle in 2020. As the economy improves, DCM investments are on the rise, with the overriding theme of being adequately compensated for risk. Favorable interest rates, paying careful attention to due diligence and adhering to tough metrics for manager selection help to mitigate risk. Looking forward, changes in interest rates, the tax environment and environmental policies will have obvious implications under the new administration. A preference for domestic rather than international investments is supported by a strong U.S. legal structure and its robust available return opportunities as 2021 unfolds.
My thanks to the panelists for joining me for an insightful conversation. You can watch the full panel discussion by hitting the play button below.
Dave Wilson is a senior account executive on the banking and securities team at Intralinks. Dave focuses on Debt Capital Markets where he advises clients on managing the exchange of sensitive documents throughout the deal lifecycle. Before joining Intralinks, Dave spent over 25 years in the financial industry working in equity capital markets/trading and in recent years advising several fintech startups.