As financial markets continue to recover from the recent economic crisis important questions arise about the new shape of credit, lending, and leverage.

·        How well, and evenly, are different credit markets rebounding?

·        What will the global rebalancing of financial power look like?  

·        Where are the financial markets now?

·        What is happening to credit availability?

 

The consensus opinion (never easy to get from folks who earn their living as Economists) is that credit markets are coming back in

inverse proportion to what set them on a great decline. All lending seemed to come to a halt until the various world governments that were in sound financial position stepped in to replace or support the small amount of private-market lending activities that were occurring.

 

In so doing and deciding to bring interest rates down to historically low levels, governments are trying to prod additional private sector lending by taking away their return from being in riskless or perceived riskless instruments.

 

Since early June we've seen an economic soft patch, fears of a double-dip recession, fears of deflation, a mid-term election and further easing by the Federal Reserve, and that is just in the U.S.!

 

Unlike many previous credit cycles, large corporate Balance Sheets were in very good shape allowing credit to come back more quickly into the large corporate sector.

 

The global deleveraging process-the process of paying down debt has changed for the positive. A brief review:

 

THE THREE PHASES OF GLOBAL DELEVERAGING

Deleveraging has been at the heart of the current economic cycle and there have been three distinct phases: 1) businesses, 2) consumers, and 3) governments. We believe that the first phase is over and

the second phase is well underway. The third and final phase, government deleveraging is now beginning as well.

Source: Wells Fargo Wealth Management

 

Phase One: Businesses.

Status Re-leveraging

 

Businesses de-levered following the technology bubble in the early 2000's, strengthening companies' balance sheets going into the financial crisis and allowing them to weather the crisis relatively well. We are starting to see these companies re-lever; that is, take on more debt. In the third quarter 2010, corporate debt issuance topped $204 billion, its highest level since second quarter of 2008.

 

Large corporations tap into large financial institutions that are in better shape right now than smaller-firm lending, and they also can tap into the public markets and pockets of capital that get created to lend there. So the supply side is there, and the risk is perceived as having been reduced significantly. This is a positive for firms of all sizes as this market confidence will eventually drift to smaller firms.

 

In addition to expanding their businesses, corporations are spending to improve productivity. Capital spending has increased in four of the last six quarters, and we are advised to expect to see further gains into 2011. As companies continue to deploy their reserves, business investment spending and job creation could see a measure of improvement, but this appears likely only if the U.S. economy can move beyond its current 2 percent GDP growth trajectory.

 

Phase Two: Consumers.

Status: Deleveraging Continues Now through 2013

 

Consumer deleveraging remains a work in progress. The amount of consumer credit that remains outstanding has been dropping for most of the past two years and savings rates have vastly improved from pre-crisis levels. All together, consumer debt (including mortgage, credit card and installment debt) has declined by about $700 billion during the last two years.

 

Consumers who have either refinanced or no longer have a mortgage have more disposable income to save or use for other purchases.

We see evidence of this increase in disposable income in improving retail sales and, anecdotally, in reports that retailers are gearing up for what they hope will be a strong holiday season.

 

Despite the improvement, U.S. consumers are unlikely to drive global growth for the foreseeable future.  Instead growth is more likely to come from fast growing economies with rising consumer classes, such as China and India.  It is this rise of the global consumer that we believe has the potential to help smooth the bumps of the global economic ride.

 

Phase Three: Governments.

Status: Deleveraging has begun, now through 2015

 

Global government deficit reduction seems to have begun in earnest. Already, we are seeing cuts being made at the local and state levels in the U.S. and austerity programs enacted across Europe, with the

U.K. embarking on one of the most severe cost-cutting plans for a developed nation in memory.

 

In the U.S., Congress has set a debt ceiling of $14.3 trillion (currently at $13.8 trillion), any increase above the ceiling requires legislative action. Now that the U.S. economy is growing again, albeit slowly,

there is a growing recognition that debt needs to be reduced. The mid-term election was, in part, a referendum on fiscal responsibility and lawmakers are likely to attempt measures to reduce spending.

 

We might start to see some spending curbs as a pre-requisite to an increase in the debt ceiling and this could start us on the path toward a decline in the growth rate of the debt, but we fear that it is still likely to take both spending cuts and tax increases to meaningfully reduce the debt. As developed governments moderate their spending, growth in their respective economies will likely remain somewhat muted. Nonetheless, global businesses and consumers are likely to continue to provide enough economic power to keep the global economy moving forward.

 

Summary

U.S. businesses have begun to borrow again at very attractive yields, and we continue to see deployment of the borrowed capital in the form of productivity enhancing capital investment and expansion abroad. The low cost of capital means there is a very low earnings hurdle for growth-related investment projects.

 

Global companies able to take advantage of the attractive borrowing costs are likely to thrive in the coming years. Consumer spending is starting to recover, but the global economy will have to depend less

on the U.S. consumer and more on the rise of the global consumer.

 

Finally, developed governments around the world are starting the deleveraging process. The removal of government stimulus as a

backdrop to economic activity is likely to be a drag on developed economies for sometime, but a relatively stronger business sector and increased spending by consumers in fast-growing emerging

markets and commodity rich nations should propel the global economy ahead and give developed economies time to heal.

 

We expect this de-leveraging process to increase the capacity for mergers and acquisitions in the staffing industry as credit will be available at reasonable rates for more firms especially those buoyed by stronger balance sheets from increasing profits and much lower debt levels.

 

So, the credit markets are at different levels of coming back from the crisis depending on the conditions they were in when they went into this cycle.

 

These factors can create some challenges for (particularly smaller) staffing firms who lack a solid Balance Sheet they can use to win over potential lenders.

 

It is never too late to get your Balance Sheet in order and it is always a great idea to do so.

 

Comment on this blog to let us know how the credit markets have impacted your staffing firm.

 

Reply Contact Sam or Bob, who have successfully completed over 120 staffing industry transactions, if you'd like to discuss M & A matters related to your staffing firm.

 

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