Easier lending standards signal lower default rates in future. Banks will usually ease their lending standards only when an upturn in the economy is in sight and companies have greater prospects for profits. During an economic slowdown the net percentage of banks tightening their standards will rise. This could be observed in 1990/91, and then during 1998 with the Asian crisis and LTCM. The last period of tight lending standards was seen between August 2000 and November 2001 when the US economy went through a recession. Since then, with improving macroeconomic data, banks started to ease their lending standards and companies’ demand for loans started to increase at the same time. Ahigh correlation of 0.79 exists between the net percentage of creditors reporting tighter standards for Commercial and Industrial loans and high-yield spreads for the period May 1990–August 2003. For the period November 1991–August 2003 the correlation between high-yield spreads and the reported demand for Commercial and Industrial loans by large and medium-sized companies is at -0.84.

Seeking to take emotion out of investing, stock analysts have invented many systems of technical analysis. Technical analysts look only at numbers.

Most believe a thorough study of stock price and volume patterns alone should allow the prediction of future prices. Some technical analysts study more factors than price and volume. All build elaborate charts and read them for clues to the future. Often, extensive computer modeling and game playing systems are employed. Economic factors, stockbroker pressure, the brother-in-law’s inside information, the CEO’s cold, and other factors are ignored.

Technical analysis is great for number people. You can play with endless formulas to analyze past trends hoping to predict the future. However, technical analysis is best employed on other people’s money. Then you can remain objective and emotionless. All the studies of technical analysis show that it is ineffective. Used on your own money, you are likely to have strong feelings as losses mount.

Calculating discretionary income is simple. There’s no need to get out your protractor or call your friend with a Ph.D. in Economics. It’s a simple three-part formula that requires basic arithmetic. Once you burn this formula into your brain, you’ll begin to see every dollar that flows in and out of your household in a different light.

Discretionary income is calculated by taking your household total income and subtracting two kinds of expenses from it: fixed and variable expenses, which I’ll discuss in a moment.

On paper, it looks like this:
Total monthly income
– Fixed expenses
– Variable expenses
_______________________
= Discretionary income

That’s it!

The principal tax-related issue normally affecting the lenders in debt for equity swap transactions is the treatment of any loss suffered as a result of exchanging debt for shares which are likely to be worth considerably less than the debt’s face value. To maximise tax efficiency, such ‘loss’ should be available as a tax shelter at the time of the transaction. In certain jurisdictions, however, losses arising from such exchanges may not be recognised for tax purposes until the disposal of the shares.

To create a structure that will secure tax relief at the time of the debt for equity swap transaction, the following factors may need to be addressed:

The reorganisation must not be structured such that the company ‘repays’ the outstanding debt and the lenders use the notional proceeds of the repayment to subscribe for the company’s shares. Instead, the transaction needs to be an ‘exchange’ of debt for shares.

If a proportion of the shares allocated to lenders relates to rolled-up interest, a further advance may need to be made to the company to notionally repay the interest, with this new ‘debt’ then being exchanged for shares. The direct exchange of accrued interest for shares is often tax inefficient.

The tax efficiency of the transaction, both in the company’s and lenders’ interests, is a key consideration in structuring debt for equity swap transactions. Often considerable value can be released from the company’s accumulated losses by structuring the transaction effectively.

There are two principal methods of accounting for equity acquired in exchange for debt:

Writing-off, or fully providing against the value of the equity. This is clearly the most prudent approach and is required under the internal regulations of many banks. However, this policy may not always accurately reflect the underlying commercial substance of a debt for equity swap transaction. This is particularly so if the principal objective of a transaction is to restore some value to the company’s equity. The risk is that this accounting approach acts as a disincentive for banks to convert the necessary level of debt into equity, and thereby fail to agree to a robust financial restructuring. There is also a possibility that once fully provided, there would be little incentive for lenders to take a proactive role in maximising the value of their equity holdings.

Valuing the shares at the lower of cost and net realisable value. For this purpose, cost is the face value of debt converted and net realisable value is assumed to be the estimated realisation at the proposed exit date. The reporting accountants’ valuation of the company’s equity is usually used for this purpose. For short-term holdings, say, realisable within one year, the market value (if any) of the shares is likely to be the
appropriate indicator of their realisable value. This is providing the market for the company’s shares is relatively liquid. The risk associated with this approach is that there is pressure to take an optimistic view on realisable value and hence use a debt for equity swap transaction to delay making necessary provisions against problem loans.

The lender’s host country or internal regulations will often restrict the options available for the accounting treatment of shares acquired in distressed clients. It is important, however, to ensure that the accounting method adopted does not distort the substance of the transaction. A swap based on the fundamental financial and business issues will ultimately benefit all the parties involved.