The securities market is one of the many areas of the economy affected by the recession. While companies continue to place equity and debt securities, the issuing landscape has evolved. A greater focus on information and due diligence and tougher regulations has changed the intermediation phase of security issuance.
“There used to be a trend to issue securities almost overnight, which meant little due diligence on the part of investment bankers and investors,” says Dr. Gabriel Ramírez, a professor of finance at Kennesaw State University Coles College of Business. “Those practices won’t continue to exist after the recession.”
Smart Business spoke with Ramírez about how securities has changed, how corporations and investors have to approach securities differently, what vehicles have become more prevalent, the state of international securities and what to anticipate in the near future.
How have the current economic conditions changed securities? Have any new markets opened or old markets closed?
Securities themselves have not changed. What has changed is the process to issue them. Traditionally, there has been a major reliance on investment banking firms. Most recently and up until 2007, there was a strong movement toward speed of issuance. It was common to see ‘overnight (bought) deals’ that were auctioned as opposed to using the traditional book-building process. There were also ‘accelerated book-built deals,’ which went through book-building, but were faster than traditional book-built deals. And perhaps more importantly there was the 144A market, which allowed companies to issue securities quickly. Because of the financial crisis, speed of issuance has changed, along with the process of issuing securities.
In terms of markets, the collateralized securities markets have practically shut down, particularly the 144A market. According to a recent Standard & Poor’s report, the total level of collateralized issuance is one-tenth of what it used to be. Results from my current research in this area reveal that issuance of collateralized securities in the 144A market is almost at negligent levels. The other markets have experienced significant drops in issuance levels. In recessions, it is expected to see such drops in public equity issuance. Due to the financial crisis, debt issuance is also down to about 50 percent of its regular levels, despite the prevailing low level of interest rates. In particular, bank loans are significantly down, as is widely known. Private equity should be the area with some relatively significant activity.
How do corporations and investors approach securities now, and what new conditions are being considered?
Previously, there was an overreliance on third-party mechanisms for monitoring and processing information. In the case of collateralized instruments, regulators and investors were relying on ratings by credit agencies. Such overreliance was prevalent across other areas but with an emphasis on investment bankers. As a result of the current financial situation, individuals will have to do more diligence, processing and monitoring on their own, and corporations will need to seek full-service intermediaries and provide greater disclosure of information. For example, investors will be doing a lot more of the risk assessment and evaluation previously inferred from third parties and ratings. The landscape for issuing securities, at least for the next few years, will be more regulated with more oversight, particularly in the collateralized market.
What vehicles have become more prevalent?
Convertible debt tends to be more prevalent in situations like this, particularly for private and small public firms. In periods of uncertainty, where the equity valuation of firms is difficult, convertible debt tends to be used more frequently. Most private investors or venture capitals tend to use convertible debt as a way to invest in small, private firms, and those are the firms that were shut down from access to capital in the current financial crisis.
What about international securities? Has anything changed there, and how does that affect the U.S.?
International securities issued in the U.S. market are mostly done in the 144A market, which up until 2006 was strong. Firms issuing securities in the 144A market tend to be riskier and more information problematic than firms issuing in the New York Stock Exchange or NASDAQ. There is less information disclosure in the 144A market. That is why the 144A market has suffered a lot more in the current economy and why international issuance has drastically reduced in the 144A.
Where do you see securities heading in the future?
Collateralized securities will be revived and will continue to play an important role in the markets. The collateralized market does provide a significant benefit to many corporations, and financial institutions, in particular, will be able to maintain the capital requirement levels by collateralizing loans. But how it’s done will be different and we should see a change toward what prevailed prior to the recent market boom. Currently we’re seeing a significant supply of equity, mostly coming from financial institutions that need to shore up their capital, but most nonfinancial corporations find it difficult to issue equity at the moment because of the recession. I believe that there will continue to be financial innovation with a strong focus on better capturing financial risk. One thing that this crisis has shown is the need for better risk assessment, particularly in complex financial securities.
Dr. Gabriel Ramírez is a professor of finance at Kennesaw State University Coles College of Business. Reach him at (404) 378-8222 or [email protected].
