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The Impact of the Recent Global and Australian Stock Market Downturns on the Ability of Australian Companies to Raise Equity
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The Impact of the Recent Global and Australian Stock Market Downturns on the Ability of Australian Companies to Raise Equity Capital
Introduction
The recent global and Australian stock market downturns emerged as a result of Global Financial Crisis (GFC) that began in early 2007 and ended in late 2009. The turmoil engulfed global markets and economies in a way that had not been witnessed for a long time. Its impact on Australian markets was heightened by the collapse of Lehman Brothers based in United States (ASX b 5). Domestic money markets in Australia receded, commodity prices dropped sharply, the local currency depreciated, offshore financing tightened and most significantly, equity prices dropped sharply. In response to this, a joint Commonwealth-government guarantee scheme for wholesale funding and banking deposits was introduced. This resulted into a large-scale government guaranteed issuance of medium term issuance of loans by the banking sector leading to a shift of funds from non-guaranteed investments to those that had been guaranteed. This restricted the availability of funding to companies which did not have the support of a guarantee. In the primary market, asset prices fell, leading to instability in the equity market prospects. According to ASX b (8), this led to a decrease in the level of IPO activity in the market. For ASX listed companies seeking to finance their operations, the inability to find wholesale funding sources implied that companies had to seek to raise capital through the equity market. As such, the secondary capital raisings particularly for larger companies remained strong during the whole period of the crisis. Thus, this paper seeks to examine deeply the impact of the global and Australian stock market downturns that occurred between 2007 and 2009 on the ability of Australian companies to raise equity capital. But first, it will be prudent briefly revisit the events that led to the recent stock market crash globally and in Australia and hence, the environment in which Australian companies sought debt or equity capital.
Events that led to the Recent Global and Australian Stock Market Downturns
As noted earlier, the recent global and Australian stock market downturns emerged as a result of GFC that began in early 2007 and ended in late 2009. According to ASX a (5), the GFC had a huge impact on credit and debt markets globally. The most dramatic impact of this was in the interbank credit market. As ASX a (5), notes, the interbank markets are essential in the functioning of the many associated financial markets through benchmark spreads between bank borrowing rates, risk free rates and credit spreads to a diverse range of bank customers ‘which span the width and breadth of a nation’s economy.’ over the course of mid-2007 to mid-2009, the interbank spreads for Australia, Europe and the US experienced extreme swings and heightened volatility. Before the GFC, credit market spreads in all markets in the three nations tended to average approximately 10 basis points. But according to ASX a (5), spreads spiked in August, 2007 and remained high and volatile for the next twelve months, before widening further in US and Europe. In Australia, it moved even higher than in US and Europe at the time of the collapse of Lehman Brothers. This blow-out in spreads led to very tight liquidity conditions and sharply high credit risks especially since market participants anticipated possible defaults by large financial institutions.
The spreads only began to reduce following aggressive interventions through monetary policy that calmed nerves and hence lowered the risk of systemic default. In Australia, this included injections of liquidity into the financial system and government intervention through offering of guarantees to financial institutions. As a result, the Australian spreads generally remained below those prevailing in oversees markets during the peak of the crisis. This reflected the relatively lesser concerns around the financial position of most major banks in Australia, which retained their strong ratings throughout the period of the crisis. However, according to Brown & Davis (2010, p.2), the dislocation in the credit and debt markets and the problems brought about by the global credit default swap market made it difficult for companies to tap short or long-term debt markets. This occurred at a time when banks were seeking to wind back their business lending so as to concentrate on their own liability management imperatives.
From the mid 2007, short term borrowing rates for the private sector in the US declined significantly and despite spiking in the late 2008 when the financial crisis was at peak, they continued to decline to historical low levels, (RBA c). In contrast, similar short term rates in Australia did not take the same trend at the beginning until when the Reserve Bank of Australia (RBA) began to aggressively ease monetary policy following the collapse of the Lehman Brothers. By March 2008, RBA had made reductions in the interest rates totalling 425 basis points. Despite the sharp reduction in interest rates in the financial market in Australia, the very tight credit conditions severely constrained the availability of short-term debt finance and bank lending to companies. Further, existence of restrictive environment for issuance of long-term corporate loans in Australia and overseas implied that non-financial entities had limited opportunities to roll over an existing debt funding or tap new resources, (RBA c). Generally, the GFC saw a fall in Australia financial turnover by 16.3%, the first decrease in a period of 10 years. Noteworthy, the turnover statistics were varied across sectors and products (Robinson, 2010). For example, OTC market turnover dropped by 4.3% while the Exchange Traded volumes reduced by 37.5%
The impact of the crisis on the Ability of Australian Companies to Raise Equity Capital
As noted earlier, the impact of the recent global and Australian stock market crisis was magnified by the collapse of Lehman Brothers. According to McKinsey Global Institute (2009, p. 8), the collapse of this entity saw a dramatic flight to government securities as uncertainty over banking systems in Australia and in overseas reached extreme levels. During the crisis a Commonwealth government guarantee scheme for wholesale funding and banking deposits was announced. This led to a large scale government guaranteed issuance of medium term issuance of loans by the banking sector which further saw a shift of funds from non-guaranteed investments to those that had been guaranteed. As a consequence, this severely restricted the availability of funding to companies which did not have the support of a guarantee. Further, lending was severely rationed leading to a reduction of corporate bond issuance and a requirement that all securitization of issuance had to be directly supported by the government. As such, liquidity in financial markets in Australia was restricted to participants who focussed on minimizing exposure to counterparties across the board.
According to ASX a (6), the severe movements in asset valuations and unprecedented volatility associated with global and Australian stock market downturns led to uncertainties for Australian companies due to the heightened risk aversion of investors to commit more capital in the extreme financial and global circumstances. According to the data collected by the National Australia Bank, the overall business confidence among investors declined at an accelerating rate in 2008 and bottomed in early 2009 (ASX a 6). This led to a significant increase in the price of discounts required to get raisings completed. As well, other costs associated with making secondary issues such as the cost of obtaining underwriting support increased.
During 2007 and 2008, deposit flows into Australian banks increased significantly above historical levels. According to the ASX a (9), a conventional safer haven investment and cash management trusts indicated large inflows during 2007. However, this was subjected to a net outflow in 2008 as redemption freezes in several hedge funds as well as other managed investments developed a contagion effect. There were also notable net withdrawals from managed equity funds between 2007 and 2008 as retail investors aimed to lower their exposure to equity investments. This explains the fact that the largest industry sector in Australia raising capital between 2008 and 2009 was the financial sector. The situation was dominated by raisings by the large four trading banks in Australia during the peak of the crisis and in the early stages of recovery.
According to the ASX a (7), the listing of new companies dried up completely in 2008 and 2009 while raisings of capital through IPOs declined considerably. The primary issuance market started to gain life again during the last quarter of 2009. New companies were completely unable to come to the market while the listed companies relied more on secondary capital, though secondary raisings dipped in early 2008 before stabilizing during the rest of the crisis period. The value of the IPOs listed on ASX was $2.5bn in 2008, which was the lowest value of $2.2bn in 2001 when global technology bubble collapsed, leading to a period of recession in the US (ASX a 7). New listings started to decline in 2007. In 2009, only 47 companies were listed, the lowest figure since 1995. According to the ASX a (7), the average value of new IPOs listed on ASX since 1995 had been worth $9.7bn with around 124 new listings every year. These trends indicated a strong increase in of risk aversion among investors which also negatively affected their drive to participate in new capital raisings. As a result of this, demand for IPOs was non-existence in financial year 2008-09, with only less than $300 million raised from this source. This performance is much low compared with the $10 billion and the $6 billion that wasa raised from IPOs in 2006-07 and 2007-08 respectively.
Further, according to Bazzani, mergers and acquisitions during the period of the crisis reduced considerably during the financial years 2008-09, 872 completed transactions were recorded, with a total value of $85 billion. In fact, out of this value, $19 billion represented a single transaction (Westpac’s acquisition of St George Bank). These trends likely affected the options to be made by companies in capital raisings. This represented a drop from $135 billion derived from 1240 transactions in the year 2007-08. As Bazzani notes, these trends represented reluctance by lenders to support such transactions.
According to Wylie (2009), there was a significant increase in financial flows into banks such as deposits which indicated that the retail investors’ appetite for risk assets had declined significantly during 2007 and 2008. This led to market volatility, which severely constrained credit conditions during the September quarter of 2008 and the March quarter of 2009 (Wylie). Consequently, the ability of companies to obtain underwriting support for their issues was greatly reduced and thus, their ability to make choices on capital raisings was affected. In fact, as ASX a (6) further suggests, “the very tight credit market conditions and very uncertain financial situations facing major global investment banks (including concerns about the solvency of some) during the period September 2008 to March 2009, made obtaining underwriting support very difficult for periods beyond a few days.” Such support was vital during the period given that companies needed to protect themselves against the high risk of a shortfall in capital raising. But Wylie notes that, during that period, underwriters were able and willing to take on underwriting risks for only a short period of time. However, as market volatility reduced, the asset values started to recover, risk appetite among retail investors returned and rights offerings started to rise in an accelerating rate. In the late 2009 companies moved back towards reliance on pro-rata issues. Generally, as Bazzani points out, the Australian equity prices mirrored international price levels over the period of crisis. During the financial year 2008/2009, ASX/S&P All Ordinaries Index had lost about 40% of its value by the third quarter of the year before its recovery in the final quarter. See the figure below.
Source: Bazzani (originally from Bloomerg)
In short, the increased volatility during the period of the crisis was particularly problematic for companies seeking to raise equity capital since the uncertainty created by the situation negatively affected the willingness of investors to commit new capital. Other impacts of the crisis on entities’ ability to raise equity capital included tighter terms and conditions, longer time taken for lending approvals and limitation of tenors.
However, as Bazzani points out, the actual capital raisings experience in Australia over the course of the global and Australian stock market downturns remained strong despite the extreme market turmoil. Responses to initial public offerings reduced considerably in the second half of 2008 and the first half of 2009, before picking up in the second 2009, when some confidence returned to the market. Listed companies in Australia relied largely on secondary capital raisings to repair their balance sheets and to reduce their debt exposures. As well, according to Bazzani companies took advantage of relatively robust profit during the period to increase the extent of reliance on internal funding to support their operations. The following figure demonstrates the steep fall in share prices and number of new equity raisings that was sustained during the first half of 2008. As indicated in the diagram, the value of new equity issues started to recover during the final quarter of the year 2008/2009 as companies took advantages of recovery in prices.
Source; Bazzani (originally from Thomson SDC, Bloomerg)
The secondary capital raisings remained strong with $98.6bn raised in 2009. This represented a 58% increase above the previous record year 2007 (ASX a14). In fact, more than half of the ASX listed companies raised some additional capital during 2009. On average, over the period of crisis, the most common secondary equity raising methods (by value) were placements which comprised of 41%; dividend re-investment plans which comprised of 18%; rights and accelerated issues which constituted 31% and others amounting to 5%. The crisis was most severe during the first quarter of 2009 during which placements comprised of 55% of the total value of secondary raisings and rights issues made up of 20%. The markets started to recover six months to September 2009 when the above proportions reversed with placements amounting to 30% and rights issues 50%. Also, the proportion of the capital raised through SPPs increased from 4% of total secondary to 9% between the first and the last quarter of 2009 (ASX a 14). According to Bazzani, entities relied on these funds to reduce leverage, increase their assets, preserve their credit ratings and make use the opportunity derived from the distressed asset sales. The prices of the placements and rights issues were arrived accurately to the advantages of the entities.
But it should be noted that a company’s size is vital in the determination of the most appropriate type of capital raising as the OECD (10) asserts. Small companies have a limited range of options and thus, they tend to rely more on placements. One of the reasons for this is the different shareholder register structures existing in smaller companies, which comprise a large retail shareholder base. Another cause is limited or no access to internal sources of finance or lending/debt finance. Also, there are various limitations on the ability of small companies to raise significant capital via a rights issue in such periods of crisis. Other reasons include the need for companies to move quickly to take advantage of the emerging favourable market conditions and in some cases, the desire of a particular entity to attract a large cornerstone investor (OECD 10).
During 2008 and 2009, around 95% of all secondary capital was raised by companies which have a market capitalisation of more than $100m (RBA b). The main capital raising choice for such companies was placements, with DRPs and rights issues also being significant options. On the other hand, smaller companies (with a market capitalization <$100m) only accounted for 5% of total secondary raisings. For such companies, placements were made up of almost two thirds of all raisings, with rights issues also being a significant contributor. From the first quarter of 2009 until the third quarter of 2009, smaller companies had limited access to new capital and during the last quarter of 2008 and the first quarter of 2009, access to new capital for the small companies virtually diminished. In contrast, large companies were still capable of raising capital for most of this period. In fact, the last quarter of 2008 was a record quarter for secondary raisings (RBA a). Conclusion In conclusion, the Recent Global and Australian Stock Market Downturns had a huge negative impact on the ability of Australian companies to raise equity capital. As noted in the essay, the crisis emerged as a result of the Global Financial Crisis that began in early 2007 and ended in late 2009. In Australia, the impact of the crisis on the stock market performance was magnified by the collapse of Lehman Brothers based in the US. During the crisis a Commonwealth government guarantee scheme for wholesale funding and banking deposits was announced leading to a large scale government guaranteed issuance of medium term issuance of loans by the banking sector. This further saw a shift of funds from non-guaranteed reserves to those that had been guaranteed. This move severely restricted the availability of funding to companies which did not have the support of a guarantee. As well, the crisis was characterized by sharp declines in asset values and heightened volatility that led to uncertainties for Australian companies. This was mainly due to the heightened risk aversion of investors to commit more capital in the extreme financial and global circumstances. However, as demonstrated in this essay, a strong capital raising performance among Australian companies enabled them to strengthen their balance sheets, providing them with an important buffer against the adverse effects of the crisis. The experience of the crisis demonstrates that the relatively flexible capital raising that applies in Australia allowed companies to raise significant amounts of equity capital at a time of severe market dislocation. Though this was unfavourable for small companies, the heightened volatility and sharp declines in asset values led to a shift of approach from renounceable rights issues towards reliance on placements and other non-renounceable rights issues. 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A, ” Focus: What we learned from the GFC: ASX’s view on the state of capital raising in Australia”, 2010, [Accessed 27, September 2011], http://www.aar.com.au/pubs/cm/focmfeb10.htm#How_d Wylie, S. “Tax review should think twice on dividend imputation and super.” The Age Business News. 2009. [Accessed 25, September 2011] HYPERLINK “http://www.mbs.edu/index.cfm?objectid=062F37E0-5056-AD5A-23C121A0A14A0C85” http://www.mbs.edu/index.cfm?objectid=062F37E0-5056-AD5A-23C121A0A14A0C85 Need help with assignments? Our qualified writers can create original, plagiarism-free papers in any format you choose (APA, MLA, Harvard, Chicago, etc.) Order from us for quality, customized work in due time of your choice. Click Here To Order Now Share this: FacebookX
