Swann Newsletter - Volume 2, May 2009

The Challenge of Raising Capital in the Current Markets   

World stock markets are working through a decline in asset valuations to an extent not seen since the Depression years 1929 -1933.  In fact the decline of the US markets over the 18 months to March was about the same (ca. – 50%) as the fall in the first 18 months of the Depression.  Recently stock markets have staged a swift rebound in anticipation of the end of recession.

The previously accepted levels of gearing and methodologies of structuring financings were abandoned almost overnight in late 2007.  The world continues to experience “de-leveraging” and “de-engineering” – this has had a direct and wide-ranging impact on economic activity.

Systemic collapse in the financial services sector was narrowly averted in late 2008.  A credit squeeze affecting even top quality corporates ensued.  Investor confidence collapsed. 

As a consequence, the Western world economies are operating in a deep recessionary environment – annualised GDP growth was minus 5% in the December 2008 quarter.  The emerging market economies, although showing positive GDP performance, have slowed far more than anticipated.

The recovery in economic activity will be slow due to the following factors:  (a) asset valuations will not recover quickly due to the negative effects of lower gearing and less financial engineering and (b) major global banks are still to be further re-capitalised before they commence to offer more normal levels of lending and other commercial activities with clients.

The massive and co-ordinated intervention by governments (bank bail-outs, guaranteed borrowings, back-up funding, and taking equity stakes in financial institutions) and significant cuts in interest rates will eventually bear fruit as well as inflation.  The US Fed and the Bank of England have resorted to very bold measures to generate lower market interest rates and free up capacity for banks to lend - by printing money to buy back government issued paper and more mortgage-backed securities.

We are continually reminded that the outlook is clouded – in March the IMF further downgraded its growth forecasts for 2009 (a sharp revision from 7 weeks earlier) and Moody’s predicts significant rises in defaults of non-investment grade debt before the end of the year. 

However in the face of this, there are small signs of improving investor sentiment and engagement in the hope that government actions and lower interest rates will “work”.

The traditional sources of capital – equity markets, bond markets and bank debt – have become far more selective.  Credit standards have risen and simplicity and transparency of corporate structures are now benchmark requirements.  Equity also will now place far more focus on free cash flow and less geared situations.

Brad Glynne
Cougar Energy Limited
General Manager - Corporate Finance