FIs – Please Think Out of the Box!

If there were any doubts that equities are in a bear market, last week’s 465 points Dow decline should end the debate. The USD index weakened as the market reduced expectations for monetary tightening in the United States and we look for the greenback to continue its slide. Housing continuing its decline in May with single family starts off for a 13^th consecutive month. Amid soaring costs, businesses are trimming production and attempting to control inventories.

It seems to me that several markets need to reverse course to get equities back on their feets; oil and inflation need to fall and the US dollar needs to make a sustained rally. The only way this could happen is, if Fed started a new policy by raising interest rates. Does anyone really think that is likely to happen? I don’t. We agree that the Fed will express a hard-line stance on inflation but they will not go so far as to raise interest rates after a series of rate cuts.

Under that operating environment, dwindling trading volumes and tumbling stock prices can be a big pain for financial institutions.

But we are seeing opportunity for financial firms to convert this bearish market into an opportunity by focusing on products such as ‘promoter funding’. Promoter funding, a part of the wholesale financing business for these firms, involves offering loans to company promoters who are keen to capitalize on rock-bottom stock prices, to shore up their stakes in companies.

Typically, promoters access these loans to buy stock through the ‘creeping’ acquisition route, convert outstanding warrants into equity shares or to buy-out other investors, which seek an exit from the company. Many new entrants have entered this business, where loans are offered at interest rates between 14 per cent and 18 per cent, with shares or property taken as collateral.

In today’s scenario, the promoters have become proactive because of market dynamics. Some lenders reserve the right to sell off the shares pledged, if the market value of the offered security erodes substantially. Share buyback proposals by corporates are on the rise, both at domestic and at global levels, as market valuations rule lower than the last year.

Follow the trend, not the so-called experts.