Conference Presentation, Panel
The Art and Science of Capital Structure
- The debate regarding capital structure is predicted to result in a 10 to 0 score in favor of Michael Milken, affirming that capital structure significantly matters, though this varies by jurisdiction; the best time to finance is when capital is not needed, while volatile industries like technology are expected to see disintermediation within two to three years and should maintain lower debt levels compared to other sectors.
- Banking capital structures are expected to remain under strict regulatory control following a revolution that began in the 1980s and intensified after the 2008 collapse, with regulators forcing banks to function more like utilities; in Europe, banks hold assets three times larger than US banks relative to GDP but possess lower capital (4.5% vs. 8.5%) and funding sources (50% vs. 85% deposits), creating a dichotomy between strong and weak credits.
- A revolution in European finance companies is anticipated over the next five to ten years as regulatory barriers force banks to reduce assets, with opportunities expected to emerge for operating companies and finance firms created from the ground up, while US small banks face consolidation starting in May due to new rules allowing sub-debt to count as equity at a three-to-one ratio.
- The current macro environment features all-time high equity markets and interest rates near historic lows, enabling companies to access leverage of six to seven times EBITDA at roughly 6% pre-tax interest (effective under 4% after tax) with long maturities and minimal covenants, creating a "frothy" market where firms may trade at 30 to 100 times earnings.
- Alternative asset managers and the shadow banking system, which has grown to over $75 trillion, are positioned to exploit gaps in the financial system left by regulated banks withdrawing assets, with plans to pursue leveraged loans, high-yield bonds, preferred convertibles, and CLOs while avoiding direct bank ownership due to regulatory risks.
- Specific firm strategies include managing $18 billion in capital (half private), anticipating changes in balance sheets through M&A or spin-offs, and capitalizing on the exit of GE Finance by hiring its talent to create or invest in finance companies, while another firm managing 30 portfolio companies intends to issue debt yielding between 7% and 15%.
- Labor and regulatory costs are driving operational changes such as automation and reduced hours, with non-investment grade companies historically creating 62 million jobs in the US from 1970 to 2000 compared to negative job creation by investment grade firms; Europe's slower growth is attributed to inhibited capital access, though asset sales from big banks (dropping from $36 trillion to $32 trillion) present further investment opportunities.
- Future risks include potential macroeconomic imbalances in the Eurozone, the possibility that "macro will do you" if investors ignore balance sheet dynamics, and the prediction that regulatory consolidation may negatively impact the American economy by reducing liquidity in capital markets as large institutions drain their balance sheets.