A Whiff of Inflation – M&A Valuations Lead the Way

Posted on July 17, 2014

(Originally Published on Axial Forum)

Since the 1970s, many of us have feared the threat of inflation looming just around the corner. Within the past year, economists and central bankers have led us to believe the inflation dragon has been permanently relegated to a dark hole, never to rain fire on the kingdom of men. We’re told that deflation is the real threat and that governments can continually run large deficits without reawakening the dragon. Recently, reality has intervened, however, to remind us that economists and central bankers aren’t infallible. U. S. Core CPI and global consumer prices have taken a sharp turn upward.

While this rate of price increase will have profound implications for business owners if it continues, that’s a story for another day.

Our story here affects these entrepreneurs more directly. Inflation comes as no surprise to those of us in the M&A business. We have watched for some time as the M&A market reheated and deal valuations reached levels not seen since 2007 – the peak of the financial bubble. We now have strong confirmation that this trend is not reserved solely for the megadeals on CNBC.

 

For larger deals that confirmation comes from Pitchbook which reported last week that, for the first half of 2014, average deal valuations reached an all time high of 11.5 times EBITDA.

 

 Median EBITDA Multiples for Buyouts (H1 2014)
For smaller buyouts, the story is the same. Andy Greenberg, CEO of GF DATA®, is in a unique position to understand middle market M&A pricing trends. His company maintains a very comprehensive database of actual transaction values in the sub $250 million marketplace. In our recent interview, Andy shared his perspective confirming our belief that lower middle market M&A purchase multiples have reached historically high levels over the past 12 to 18
read the rest

Mezzanine Financing for Smart Guys

Posted on August 5, 2013

No Dummies here — our clients and friends tend to be very bright people.  Because they also tend to be very busy, we thought it might be helpful to use our most recent closing to provide a brief primer about middle market mezzanine financing.

You can click on the tombstone image to the left to get the full details of the $5 million mezzanine debt placement we arranged for our fast growing, innovative client, Paramount Merchant Funding LLC.

Mezzanine debt is a key component of leveraged private equity financial structures, but it also serves an important role for companies operating in the middle market.  As companies grow rapidly, their capital needs frequently outstrip the capital available to them.

Typically new enterprises are funded with the founders’ personal capital and loans supported by their personal assets or credit.  Often they reach out to friends and family to provide additional support. Additional working capital may be provided by a factor or an asset based lender; however, if growth is rapid, the business will eventually outstrip the limits of these resources and the founder’s personal financial resources will not  support continued growth.

For a step-by-step video how-to guide for obtaining mezzanine financing, click on the image below and view the tutorial.

To download the associated PowerPoint Slides click here.

In the past the needed capital was frequently provided by banks which relied upon the borrower’s character in addition to the liquidateable value of its assets. That is a thing of the past. Today, banks without clear collateral  support to back their loans will soon invite the ire of regulators. With this regulatory threat hovering over them, most bankers have effectively abandoned the small business community in its time of need.

This has created a financing gap increasingly filled by mezzanine lenders. These firms are often structured … read the rest

Damn Those Shadow Banks!

Posted on March 3, 2013

Authored by John Mason – Originally Published at Seeking Alpha – Reprinted with Authors Permission

What do we do about the shadow banks or, more politely, alternative finance sources? David Reilly brings us some of the regulatory dilemma in the Wall Street Journal, “Too Big to Fail Casts a Very Long Shadow.”

The question is, “Should the U. S. Government look to backstop even more of the financial system than it already does?” The financial system is expanding. The financial system has already expanded.

Reilly writes that “the shadow-banking system is estimated at between $10 trillion to about $24 million, depending upon the activities included.” According to Federal Reserve System, the commercial banking system holds a little more than $13 trillion in assets.

According to the Federal Deposit Insurance Corporation (FDIC), the total of all assets held by all FDIC insured institutions is a little more than $14 trillion. According to Gary Gorton, Yale economist, in his latest book, “Misunderstanding Financial Crises: Why We Don’t See Them Coming,” the shadow banking system totaled something around $10 trillion to $14 trillion in the summer of 2008, just before the financial crisis started.

In June, 2008, the assets of the commercial banking system totaled just over $11 trillion; assets in all FDIC insured institutions totaled just over $13 trillion. Alternative financial institutions are something to deal with. And, alternative financial institutions are attracting more and more attention.

The issue about shadow banking is one about systemic financial collapse. And, in other words, as Federal Reserve Governor Daniel Tarullo stated before the Senate Banking Committee last week, the regulation of this part of the financial system is the issue “we should be debating in the context of too big to fail.”

Reilly writes, “While banks have faced tighter oversight, the shadow banking market remains a … read the rest

Citigroup Changes Reflect Banking Industry in Transition

Posted on December 6, 2012

John M. Mason

Banking, in the past, has always been about people. Banking was built up around customer relationships and you had to have people to create customer relationships.

Bank of America (BAC) has about 275,000 employees; Wells Fargo (WFC) has some 265,000; JPMorgan Chase (JPM) has about 260,000; and Citigroup (C) also has around 260,000 employees.

Banks needed people to relate to their customers, to entertain their customers, to solve problems for their customers and to smile at their customers. People, we were told, were the “face” of the bank.

But, observers of the actions taken by Citigroup argue that this is only the first step, according to a piece in the Wall Street Journal, the “opening salvo in a wave of cutbacks, business sales and other moves that could reduce the company’s global reach.” In another article in the Journal it is argued that this move “had better not turn out to be the whole show. Citi still needs reinvention.”

Departments need to go. Subsidiaries need to go. And, so on and so forth. The bank needs to be structured for the twenty-first century.

I certainly agree that commercial banks need to restructure. And, I certainly agree that banks need to become less of a “people” business. But, this is all a part of the evolution of the banking industry.

Let me begin with a true story.

In 1972, I joined the faculty of the Finance Department of the Wharton School at the University of Pennsylvania. This department was one of the leaders in the “new wave” of financial research talking about “betas” and the “CAPM model” and other such exotic topics of the time.

My background was banking and there were no courses at the time at Wharton about the management or … read the rest

Evolving Financial Institutions

Posted on November 20, 2012

So much of the world is in transition, why do people want the commercial banking industry to be what it was many years ago? This is just not going to happen.

As I have written many, many times, finance is information! We have seen, over the past fifty years or so how the advancements in information technology have contributed, for better or worse, to the innovations that have taken place in financial institutions and financial instruments.

Given the continuing advancements in the information technology field how can we not expect the financial field to continue to evolve? Check out all that is being done in mobile banking these days. At least in my area of the world I am seeing more and more advertisements about mobile banking and what it does for the customer.

And, this is just the ground level. More and more people you talk with and read about claim that they have only gone into a bank office once or twice in the past two or three years. And, the only reason they went into the bank was to complain about not receiving notifications from the bank that their interest rates were being dropped. If this is not enough, read David Wolman’s book, “The End of Money” (Da Capo Press, 2012).

But, who is going to even keep their money in a typical commercial bank? I don’t. I work with an institution that satisfies my banking needs and ties all my financial relationships together so that I can move seamlessly from one asset class to another almost instantaneously.

How about my mortgage? (Yes, I have one!) The commercial bank I know set me up with their affiliated mortgage that immediately sold the mortgage to Wells Fargo (WFC), which now just services the loan because it is owned by Fannie … read the rest

August 2012 – The Future of Small Business Financing

Posted on August 23, 2012

Everyone loves small business.

At least that’s what the politicians want you to believe.

The reality is different. Small business is under attack from every quarter. Government policies favor large banks and large multinational businesses. Credit is tight and the banks favor the larger borrowers. Increased regulations stifle innovation and protect large incumbents that can afford teams of lawyers and lobbyists.

What’s the little guy to do? Waiting for the politicians to change the system is wishful thinking. Smart business people find ways to prosper in every environment.


And the current environment is not great for small firms. The Federal Reserve Senior Loan Officer survey has recently confirmed what we have suspected for some time: banks have been more generous in easing underwriting requirements for larger companies than they have been for smaller companies. Paynet, which maintains data on 17 million small business loans, reports that lending conditions for small firms have deteriorated in recent months after two years of bounce back from the 2009 bottom.  For additional details go to the full article on Capital Matters.


Financial Market Risk
And there’s a risk that things could get a lot worse for businesses that don’t tie down their financing soon.  We just published an article on Seeking Alpha that has received a great deal of attention with more than 14,400 page views so far. Our thesis is that the Fed’s zero interest rate policy has led to a situation where longer term treasury bonds are trading at yield levels that provide a spread to inflation far below the historical norms. Markets eventually return to their mean and often overshoot it so there is growing risk in the longer term debt market. Our concern is two-fold. First, that individual investors need to be aware of the potential impact of this return to the mean … read the rest

A Swan Blacker Than The Darkest Night

Posted on August 18, 2012

Interest Rates Rise at 2652% Annualized Rate! That’s probably a headline you will not see in the Wall Street Journal and it’s certainly a bit over the top, but those are the facts. From July 18 to August 17, the interest rate on the two-year Treasury jumped from .22% to .29%. That’s a 32% one month increase and works out to an annual jump of 2652% if you compound the increase monthly. Just to be fair the ten-year rate “only” rose from 1.52% to 1.81% or about 19% over the same period. With the magic of compound interest that generates a far more benign 713% annualized rate rise.

If you haven’t already done the math, those growth rates would take you to a 43.8% annual interest rate on the two year a year from now and a 12.9% interest rate on the ten year at that point. Of course that is not going to happen. Most likely we’ve just seen a random fluctuation in an overbought market. The Fed has promised to keep interest rates low for an extended period after all.

We’ve been saying for some time that the seeds have been planted for a move into a period of stagflation comparable to what we saw from the mid-1960’s and the 1970’s. That move, which transformed the benign inflation of the 1950’s to a raging inferno by the end of the period, eventually took Treasury rates for the 10 year to unheard of levels of 15% by the end of the 1970’s. This resulted in a collapse of the bond market and the eventual failure of entire savings and loan industry in the United States in the 1980s.

The United States and most of the developed world have benefited tremendously over the past 30 years from a steady drop in long-term bond rates.… read the rest

Financial Innovation Aids Small Business Borrowers

Posted on August 15, 2012

The most recent Federal Reserve Senior Loan Officers Survey conducted at 64 large banks confirms what we have suspected. After a long period of tightening, loan standards have stabilized and for larger borrowers they have loosened slightly. The survey provides less hope for smaller borrowers, shown in red on the chart below.

(Click on Image to enlarge)

This confirms data we published previously showing that small business lending has entered into a choppy period in 2012 after seeing moderate improvement from the 2009 lows during 2010 and 2011. Things are only likely to get worse for smaller borrowers as their natural allies, the community banks, struggle with maturing underwater CRE (commercial real estate) loans, continued pressure from their regulators and rapid industry consolidation.

FDIC data shows that bank credit availability is likely deteriorating for many cash starved small businesses. From December 31, 2010 to March 31, 2012, C&I (commercial and industrial) loans at banks over $1 Billion, i.e. those that focus on lending to large multinationals and mid-sized domestic firms, grew approximately 20% from $1 Trillion to $1.2 Trillion. For banks under $1 Billion, i.e. those most focused on small business lending, C&I  loans actually dropped 6% during the period from $110 Billion to $103.5 Billion.

We increasingly see smaller firms struggle to obtain funding if they do not have adequate hard collateral (equipment, inventory or receivables) or if the owners don’t have personal assets to pledge to support the loans. If you are a small business with a capital need to support a growing business, you’re asking “what options do I have?” Recently some innovative non-bank financial services firms have stepped into the breach and are beginning to offer new forms of small business finance based not on specific collateral, balance sheets or income statements, but on a company’s proven ability to generate … read the rest

U. S. Small Businesses Heading Into Choppy Waters

Posted on August 9, 2012


Source: Paynet

Small business lending has grown steadily since the end of the recession.  The Thomson Reuters/PayNet index focuses on loans to borrowers with total indebtedness under $1 million.  In a related story it was reported that preliminary June data not reflected in the chart above shows a sharp 5% drop in small business lending.  The article paints a rather gloomy picture for small businesses and the economy as a whole.

PayNet President William Phelan explained, “Businesses and bankers should prepare for more slowdown. Now might be the time to consider adding capital. Credit supply is high and interest rates are incredibly low.” Phelan added “banks should strengthen credit quality to prepare for further slowdown. Stress Tests show that a full blown recession means small business failures could triple.”

According to Paynet the Thomson Reuters/PayNet Small Business Lending Index (SBLI) measures the volume of new commercial loans and leases to small businesses indexed so that January 2005 equals 100.  Because small businesses generally respond to changes in economic conditions more rapidly than larger businesses do, the SBLI serves as a leading indicator of the economy. The index is a highly correlated leading indicator of the GDP by 2 to 5 months.

There is some good news in the report.  Small businesses have been steadily improving their balance sheets since the beginning of the recession and loan delinquencies are at historically very low levels, with severe delinquencies much lower than 2005 the first year for which data is available.  However, the report goes on to say that small business investment rates are lower than in 2005 as companies pay down debt and build cash.  Banks are under-loaned with loan to deposit ratios of 60-70% and are competing hard for the few high quality loans that are available.  While businesses are being cautious in this difficult … read the rest

January Video Newsletter

Posted on January 26, 2012

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