Current market conditions scream out for convertibles, preferred shares and other hybrids, Norton Rose reports

Andrew Lewis, Partner in the Middle East Corporate Finance group of International law practice Norton Rose (Middle East) LLP explains below the current shift in the capital market:
• If there is a significant risk a borrower won't be able to meet its commitments on a debt facility with a normal interest or profit rate, that risk will only be heightened by increasing the interest rate. A higher rate becomes counter-productive for the lender and borrower.
• Convertibles, preferred share and other hybrid securities can bridge the gap between companies in dire need of cash and potential financiers, who are either cautious or simply seeking terms which reflect the enhanced value of their capital in the current global market conditions when capital is king.
• In this environment, Islamic financiers and capital seekers should at least explore whether they can replicate similar commercial outcomes as are delivered by these alternative structures in a Shariah compliant way so they are not disadvantaged or hamstrung.

Convertibles

In some cases structuring a facility so it is convertible to equity may be sufficient to bridge the gap between a lender who has is prepared to take more risk in return for a higher potential reward and the prospective borrower.

The option to convert a loan to equity some time in the future, but at today's price, should provide a financier with significant potential upside (provided the borrower gets through to better times), as current valuations are very low.

Preferred Equity

For equity investments, one way to bridge the valuation gap which is prevalent in the current climate is to issue preferred equity. Preferred equity can take many forms but the most attractive terms will provide the investor with a specified return in priority to ordinary equity but also allow the investor to fully participate in any upside if a higher return is achieved for ordinary shares.

The preferred rights typically provide the investor with a measure of downside protection not available to the other ordinary shareholders without forgoing any upside, such that the investor is prepared to pay a higher price than it would otherwise pay for ordinary shares.

If you wish to speak or meet with Andrew Lewis please let me know and I shall fix something in his diary.