In a world where credit availability drives the economy, here's what happens when banks aren't willing to lend!

Wednesday: The Independent Investor FROM THE DESK OF MILES EVERSON: Happy Wednesday! I hope you’re having a great week so far. In these “The Independent Investor” articles, I talk about various tips and topics about investing. My hope is that through these, I’ll be able to share essential and strategic insights to help you boost your investment portfolio and achieve financial stability in the long run. Today, let’s talk about corporate credit Keep reading below to know whether or not corporate credit (at least in the U.S.) is in good shape this year. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

In a world where credit availability drives the economy, here's what happens when banks aren't willing to lend! There’s an issue that has been concerning big banks in the U.S. since last year: Private equity (PE) has overstayed its welcome. For those of you who aren’t familiar with it yet, PE refers to capital stock in a private company that does not offer stock to the general public. This type of equity is offered instead to specialized investment funds and limited partnerships that take an active role in the management and structuring of the companies. According to Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, PE firms are eager to keep making deals. The problem? These firms are having trouble securing their usual debt capital from large bank loans. [Debt Capital: A capital that a business raises by taking out a loan that is normally repaid at some future date.] Professor Litman says this issue stems from past transactions. Banks still hold debt from prior PE deals on their balance sheets. Take for example Citrix Systems, a software company that went private in 2022 in a deal worth USD 16.5 billion. This was done with help from PE firms Elliott Management and Vista Equity Partners. Big banks like Bank of America, Credit Suisse, and Goldman Sachs were also involved in the process. They incurred collective losses exceeding USD 500 million from the debt supporting the transaction. Meanwhile, other banks like Barclays and Morgan Stanley still owe money from when Elon Musk bought Twitter. Because of this, many banks have become hesitant to lend any more money to PE firms nowadays. Thus, these firms are forced to explore alternative financing sources like private capital, which often come with higher interest rates. [Private Capital: The umbrella term for investment, typically through funds, in assets not available on public markets.] … and according to Professor Litman, this is a classic example of what happens in a credit crunch. [Credit Crunch: A sudden reduction in the general availability of loans or a sudden tightening of the conditions required to obtain a loan from banks.] Let’s look at two metrics that point to a worrying setup in today’s economy: Senior Loan Officer Opinion Survey (SLOOS) At Altimetry, the SLOOS is one of Professor Litman and his team’s favorite ways to track credit standards in the U.S. Basically, the SLOOS is a quarterly survey from the Federal Reserve. The survey gathers information about lending practices in the U.S. by asking loan officers if their lending rules have tightened, eased, or remained unchanged in the past three months. In a recent SLOOS report in 2023, 51% of banks indicated they’ve made their lending standards stricter. That’s about as high as it gets before the U.S. hits recession levels… This shows that when times get tough, banks can’t just assume they’ll make their money back on loans. Recovery Rate So, what happens when banks can’t rely on loans? They look at the recovery rate, or the value of a company’s assets compared to its debts. This gives banks an idea of how much money they would recover in bankruptcy. … but right now, recovery rates look HORRIBLE. Take a look at the chart below that shows the aggregate recovery rate for the 1,000 largest U.S. companies. If it holds where it was in 2023 today, companies will have their lowest recovery rate in 30 years. According to Professor Litman, this is a HUGE cause of concern for banks today. No wonder they’re tightening standards so fast! With tighter credit conditions, these banks are hesitant to lend any more money to PE firms. In an economic downturn, PE-backed companies may struggle to generate the returns needed to repay their loans. In essence, banks are the “canary in the coal mine.” When they tighten their purse strings, it means they’re bracing for economic headwinds. As finance professionals know, credit availability drives the economy. This means if banks are unwilling to lend, expect that this is what will come next: Companies that need to borrow will be starved for capital to the point of bankruptcy. So, as an investor, keep an eye out for the SLOOS data. If tightening gets any higher, that’s another sign that the credit market is in bad shape. ANNOUNCEMENT: Navigate the lucrative world of resource investing with ease and expertise! The Rick Rule Natural Resource Symposium will return to The Boca Raton in Florida on July 7 to 11, 2024 to deliver reputable insights on resource and commodities investing. In this one-of-a-kind event, you’ll have the chance to learn from the industry’s “living legends” as they share countless opportunities and strategies to enrich your portfolio, as well as enjoy great company and lively conversations with your fellow attendees. My friend and colleague, Professor Joel Litman, is part of the speaker lineup. I highly encourage you to join! Register now through this link to secure your slot. You have an option to register as an onsite attendee or via livestream only. Hope to see you there!     Hope you’ve found this week’s insights interesting and helpful. EXCITING NEWS AHEAD The world of work has shifted, and there’s no going back. The barriers to entry have never been lower for talented professionals to work independently, and today’s massive external workforce is hardly a pandemic-produced fad. Business owners can only survive in the new work landscape by partnering with this deep talent pool. 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Learn more about the status of this airline company’s stocks in next week’s article!