Start Spreading the Views…
28 November 2006
Taking a brief look at some current trends in the US fixed income market, we see that certain sectors are experiencing some notable shifts in average spreads for new debt issues:
In the past 30 & 90 day periods, significant increases have been experienced in telecom, healthcare and consumer discretionary segments of the economy compared to the trailing 12 month average. In some cases, this increase has been 100 basis points or more. Conversely, consumer staples and materials have been on the decline. What do the proverbial tea leaves have to say about these trends?
The possibility exists that the economy is reaching the peak of a cycle a supposition reinforced by recent all-time stock market highs that have been experienced. The market in turn, is assigning higher risk premiums to the more volatile sectors of the economy most likely to be hardest hit in the event of an economic downturn – namely high tech, biotech and areas of discretionary spending. As investment dollars still need to find a home, they are being funneled toward more traditional industries, driving down the spreads on staples and hard goods.
What all does this mean for venture debt financing in Canada? In my opinion, there are two important lessons to take away.
First, venture debt remains an important source of funding for businesses in the affected sectors – such as tech – as an increase in the interest spread will often indicate an even greater increase in the cost of equity (see my discussion of market risk premiums in my previous post, “Is your WACC out of whack?“). As a result, venture debt can be an effective way to reduce cost of capital, particularly until the point in which the market as a whole is more receptive to these riskier stories.
The second takeaway is that venture debt in Canada has provided a much more stable cost of financing which does not fluctuate nearly as much as debt in the US for example. With swings of 100 basis points or more in either direction, companies may become preoccupied with trying to time the market to achieve the best deal possible rather than contentrate on running their business. Venture debt on the other hand, can offer a predictable cost of financing, available when the company needs it most, not just when the markets deem it appropriate.
JN
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