In The Headlines
Loan Trading: A $1 Trillion Market Moving in Slow Motion
Imagine a trillion-dollar business that runs on phone calls and faxes and routinely ties up money for months while investors receive no interest. That is how it goes in the market for leveraged loans—those made to highly indebted companies with low credit ratings. At a time when trading in all kinds of securities is increasingly automated and subject to greater scrutiny by regulators, leveraged loans trade 1980s-style, in a clubby world where the biggest Wall Street banks set the rules.
The antiquated structure of the market poses a growing threat to the financial system at a time when investors expect to get their money with a click of a button. As the market ballooned from $35 billion in 1997 to more than $1 trillion, technology did not keep pace. The time it takes to complete a transaction lengthened to an average 23.4 days as of March from 17.8 days in 2007, according to data from the Loan Syndications and Trading Association (LSTA), an industry lobbying group. Investors need approval from the corporation that borrowed the money before they can trade loans among themselves. Clerks must manually change documents to reflect any new ownership. “There’s a high amount of faxing going on still,” says Virginie O’Shea, a senior analyst at bank research firm Aite Group. “People don’t realize that fax machines are still around in this day and age, but they are.”
It is not just professionals who have money at stake. Drawn by the prospect of higher yields, investors poured an unprecedented $62.9 billion into mutual funds that buy the speculative-grade debt in 2013.
Mutual funds purchased 32% of the loans issued that year and held 25% of all outstanding loans at yearend, according to the LSTA. The danger is that if interest rates rise and loan defaults increase, a mass exodus from leveraged loan mutual funds could lead to financial gridlock. “It’s a critical issue,” says Elizabeth MacLean, a money manager at Pimco, which started a mutual fund to invest in leveraged loans in 2011 that now has $2.3 billion in assets. “Any single retail fund not being able to meet their redemptions would have a ripple effect on the whole market.”
Even so, regulators are not doing anything to address the market’s shortcomings. Securities laws do not apply to loans, which are contracts. When regulators were drafting securities laws in the 1940s, loans were largely held by the banks that made them. That changed in 1982, when James Lee of Chemical Bank (now JPMorgan Chase) pioneered the practice of selling parts of loans to other banks and investors, making them more like stocks and bonds.
New loans can be subject to some of the worst delays, according to Pimco’s MacLean. Investors who committed $1.2 billion in October to fund a loan to Huntsman, whose debt is rated below investment grade, expected to receive millions of dollars of interest every quarter. Eleven months later, they have not received any of the interest they signed up for. Huntsman needed the loan to help pay for its acquisition of Rockwood Holdings’ titanium dioxide business, and the purchase has taken longer than expected because of an antitrust review. “No interest has been due yet,” Kurt Ogden, a vice president for investor relations at Huntsman, said in August.
One reason there has not been a movement to streamline trading is that Wall Street can benefit from the market staying the way it is, according to Scott Page, director of bank loans at mutual fund company Eaton Vance. When banks agree to make a loan, they earn commitment fees to compensate for the risk that the market might fall apart before the loan closes. Investors in loans do not earn those fees, and they have started to push back, demanding fees on loans that fail to settle within a designated period.
Bram Smith, executive director of the LSTA, says banks have no incentive to drag out the time it takes to settle. “It’s a well-known fact to market participants that loan settlement is different from that of other asset classes,” he says. By recognizing the difference, he says, both mutual funds and other investors have “prospered and grown quite nicely.”
Family Spirits: Alex Ricard Takes Over at Pernod Ricard
Alexandre Ricard has waited to run his family’s spirits business for practically all of his 42 years. In February 2015, the Frenchman will take the reins as CEO and chairman of Pernod Ricard, the $10.8 billion distiller and owner of marquee brands like Absolut, Chivas Regal, and Jameson. Ricard has been the company’s Chief Operating Officer since 2011 and first joined in 2003 after stints with Accenture and Morgan Stanley.
Ricard was named as successor in August 2012 by current CEO Pierre Pringuet after a heart attack caused the death of then-chairman and former CEO, Ricard’s uncle Patrick. At the time, Daniele Ricard, Patrick’s sister, was named chairwoman. In February, Pringuet will turn 65, the mandatory retirement age stipulated by the company, and Alexandre will replace both of them.
Ricard faces three top priorities: global top-line growth by pushing brands in key battlegrounds like China and the emerging market in Africa; innovation, in both design and product; and marketing with a focus on brand heritage.
Much like beer giant Anheuser-Busch InBev, Pernod Ricard is the result of multiple unions over time. Pernod, an anise-flavored liqueur, has been a French staple since 1805. Ricard, an apéritif, was created in 1932 by Alex’s grandfather Paul. Longtime rivals for French palates, the two merged in 1975. Some of the company’s key acquisitions since then have been Allied Domecq in 2005 (and with it, Beefeater, Ballantine’s, Kahlua, and Malibu) and V&S Group in 2008, which added Absolut, the top-selling premium vodka in the U.S. today.
Roughly a third of Pernod’s business is in Europe, another third in the U.S., and the final third in Asia. That last market has huge growth potential, but it is far from simple. China has had a precipitous drop in sales of imported spirits, which experts trace to the Chinese broadly cutting back on luxury. According to Morningstar analyst Philip Gorham, “They’re cracking down on public officials accepting gifts and conspicuous consumption, and that affects premium spirits and Scotch. At some point they’ll hit reset, and it’ll grow again, but that’s going to be one of Pernod’s big short-term problems.” Indeed, the company’s revenues for the last fiscal year were flat solely because of a 23% sales drop in China and an unfavorable exchange rate. Its stock, which trades on the Euronext Paris, rose only 4% in the past year.
Ricard plans to address his China problem by ramping up Pernod’s wine portfolio there. In 2012 it bought the Helan Mountain winery, and an Australian wine it bought in 1989, Jacob’s Creek, sells very well in China. And he will use new sub-brands to target specific groups, which Pernod has done with Martell Distinction, a new line of affordable cognac that it says is selling well among China’s emerging middle class.
Ricard, known to be strait-laced and serious, he is nevertheless well aware of the generation dubbed “millennials” and in 2012 Pernod launched T-shirt OS, a shirt that can display personalized messages. Wearable tech is new and perhaps strange ground for Pernod. However, the product was consistent with the company’s brand and was funded by Ballantine’s Scotch, whose advertising tag line is “Leave an impression.” Along with the shirt, Pernod is testing an at-home bar appliance called Project Gutenberg. Both are part of Ricard’s initiative to invest 20% of the marketing budget in digital innovation.
Sources:
1. http://buswk.co/1v7hc4s – Businessweek
2. http://bit.ly/1p3Cg82 – Fortune
The Good News Is . . .
• Inflation in August only increased 1.7% from the same time last year, according to the latest government data. That is below the Federal Reserve’s 2% annual target. The August rate was the first decline in inflation since the spring of 2013. The Conference Board says its index of leading indicators rose 0.2% in August, the seventh straight increase. That was slower than the revised 1.1% gain in July. Conference Board economist Ken Goldstein says even with the slowdown in August, the index shows the economy is still gaining traction.
• Tiffany & Co., a leading jeweler and specialty retailer, reported earnings of $0.96 per share, an increase of 15.7% over year-ago earnings of $0.83. The firm’s earnings topped the consensus estimate of analysts by $0.11. The company reported revenues of $992.9 million, an increase of 7.2%. Management attributed the company’s results to solid sales growth in its store in the Americas and Asia-Pacific regions, as well as improved gross margins.
• SAP said it had agreed to acquire Concur Technologies, an enterprise software company based in Seattle, for about $8.3 billion. Concur makes software that helps companies manage employee travel and expenses, a growing market as international business travel continues to grow. SAP will pay $129 a share for Concur, expanding the German technology giant’s suite of web services offerings. Founded in 1993 and taken public in 1998, Concur reported $546 million in revenue for the last full year, continuing a run of sharp sales increases.
Sources:
1. http://cnb.cx/1uchSIQ – CNBC
2. http://cnnmon.ie/1moClHS – CNN Money
3. http://www.cnbc.com/id/18080780/ – CNBC
4. http://bit.ly/1rrcpvR – Tiffany & Co.
5. http://nyti.ms/1uLttNX – NY Times Dealbook
Planning Tips
Tips for Evaluating Person-to-Person Loans
One investing strategy getting a lot of press lately is the peer-to-peer (P2P) loan. Peer-to-peer lending is the practice of lending money to unrelated individuals, or “peers,” without going through a traditional financial intermediary such as a bank. This lending takes place online on peer-to-peer lending companies’ websites using various different lending platforms and credit checking tools. Lenders can make loans in small amounts if desired and invest in multiple loans. Below are some guidelines for understanding this new type of investment. You should consult with your financial advisor before considering making a P2P loan.
Understand how P2P lending works – The interest rates are typically fixed by the intermediary company on the basis of an analysis of the borrower’s credit. Borrowers assessed as having a higher risk of default are assigned higher rates. Lenders mitigate the individual risk that borrowers will not pay back the money they received by choosing which borrowers to lend to, and mitigate total risk by diversifying their investments among different borrowers. The lending intermediaries generate revenue by collecting a one-time fee on funded loans from borrowers and by assessing a loan servicing fee to investors (either a fixed amount annually or a percentage of the loan amount). Because many of the services are automated, the intermediary companies can operate with lower overhead and can provide the service more cheaply than traditional financial institutions.
Research the notes and understand the risks – The first step is to research the notes available. As with any investment, you want to understand how P2P lending works and do your due diligence before you take the plunge. Start by reading the borrower’s profile, and purpose for the loan. Some borrowers do not share many details about the loan, or why they are borrowing. This can be a red flag. Instead, invest in notes from borrowers who have more to say. Do they state the reasons for their loans? (Debt consolidation is the most common). Is there an explanation of how the borrower plans to repay the loan? And, if there is bad credit involved, are there extenuating circumstances? Also, remember that the lender’s investment in the loan is not protected by any government guarantee. Bankruptcy of the peer-to-peer lending company that facilitated the loan may also put a lender’s investment at risk.
Consider holding P2P notes in your IRA – One of the great things about P2P lending is it is possible to hold notes in your individual retirement account. You will need to check with your current custodian about whether or not P2P loans are an option for your IRA. If not, you can open a self-directed IRA with a custodian willing to allow you to hold P2P notes. Additionally, some P2P lending sites actually offer IRAs. That makes it a little easier to enjoy tax-deferred or tax-free returns on your P2P investments.
Reinvest your money – Get more from your portfolio by reinvesting your gains. As borrowers repay their loans, your account grows. When you reach the minimum threshold to invest in a new note (usually $25), you are often alerted. You can then log in to your account and either withdraw the money, or reinvest it. Reinvesting your returns allows the income you receive to be put back to work for you. This can help you improve your returns overall, and build your portfolio at a rapid rate. Over time, as you have more to invest in notes, you can use P2P loans as part of your income investing strategy.
Diversify to improve your returns – P2P lending sites rate borrowers according to their credit. The higher the credit rating (usually on a scale of A to F, with A the highest), the lower the return you can receive. The theory, as with any other loan or investment, is that the lower the risk, the lower the interest rate. If you want the potential for higher returns, you need to invest further down the list.
Sources:
1. http://bit.ly/1wY6Urv – Zacks.com
2. http://bit.ly/V1ZiUg – US News & World Report
3. http://bit.ly/1re4ujL – Wikipeia
4. http://bit.ly/1C2jru7 – ConsumerFu.com
5. http://bit.ly/ZAHp1L – FinancialMentor.com
6. http://bit.ly/1sgfT6r – GetRichSlowly.org
