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The impact of interest rates on law firms - part 1
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<blockquote data-quote="Jaysen" data-source="post: 190" data-attributes="member: 1"><p style="text-align: center"><strong>The impact of interest rates on law firms - Part 2</strong></p> <p style="text-align: center"></p><p><strong>How do I connect commercial issues to law firms?</strong></p><p></p><p>First, it helps to understand that law firms are a service business. Clients pay law firms to handle their legal work and the legal work they do will vary between departments. We can simplify this so it’s easier to understand: Corporate lawyers advise clients who want to buy companies. Finance lawyers help clients raise money. Litigation lawyers help clients handle disputes. And so on.</p><p></p><p>A news story could impact law firms in two ways. First, you can think about the impact on clients. Let’ s suppose your commercial issue leads to a rise in M&A activity. So now, you want to connect it to law firms. Let’s call your law firm Franklin & Associates. On a basic level: If corporate clients are doing more deals, they'll need more legal advice. That means corporate teams at Franklin & Associates will be busier. They may also be doing deals of a bigger value, so the law firm may see a boost in revenue. To go further, you could tailor your answer by comparing it to other law firms. For example, perhaps Franklin & Associates X can complete due diligence at a lower cost because of its investment in technology or a legal services centre. Maybe this’ll mean it’ll have an opportunity to advise on more deals.</p><p></p><p>You could also discuss what the law firm can do to help clients. Suppose this time, we were talking about some kind of market crisis. You might suggest that Franklin & Associates help clients with their contingency plans. For example, it could develop draft wording for a new contract clause or keep clients up to date through regular research reports. This would help to protect clients from losing business in the region. You might also point out – after research – that some international clients have a lot of exposure to the market. So, Franklin & Associates may want to advise clients to scrutinise their contracts or limit the extent of any planned projects or supply chains in the market.</p><p></p><p>You can also answer this question by thinking about the impact of a commercial issue on law firms. The issues can be a little harder to discuss, but you will have less trouble connecting the issue to a law firm. An upcoming example is the General Data Protection Regulation (“GDPR”), which places strict rules on the use of data for law firms and their clients. You may want to confirm why it applies – does Franklin & Associates have a presence in the EU? If not, does it represent clients in the EU, or hold data on EU clients? Then think about how the law firm could prepare for the GDPR, it may want to carry out an impact assessment or an audit of the firm’s contracts. Or it could hire an external specialist or invest in software tools – you can explain why accuracy is very important (think about the consequences of a failure to comply).</p><p></p><p><strong>So, what’s the impact of interest rates on law firms?</strong></p><p></p><p>I’ll explain how a rise in interest rates tend to affect clients in various departments of a law firm.</p><p></p><p><strong>Mergers & Acquisitions</strong></p><p></p><p>It’s possible to argue that M&A activity will fall if interest rates rise. That’s because it’ll become more expensive to fund acquisitions using debt. This will be an issue for leveraged buyouts - where companies use a lot of borrowed money to fund an acquisition. It could also affect the valuation of target companies. If borrowing costs eat into profit margins, acquirers may not be willing to pay as much.</p><p></p><p>On the other hand, if companies are seen to be more affordable, the volume of M&A deals could increase. The valuations of companies have been rising in recent years, so an increase in interest rates may be a good thing. Even if this isn’t the case, many companies have built up cash reserves, also known as dry powder, so they're pretty resilient to a rise in interest rates. The economy is also doing well - that's why interest rates are increasing in the first place, so companies may opt to expand because they’re more confident in the state of the market.</p><p></p><p>You can also nuance this argument by picking certain geographies (developed nations v emerging economies) or sectors (utility companies v tech companies).</p><p></p><p><strong>The financial sector</strong></p><p></p><p>A rise in interest rates is generally good for the banking sector. Banks make more money from the difference between their portfolio of loans and investments and what they pay savers. This also applies to insurance companies and pension funds who have lots of cash to invest in securities, so they see a better return to cover their commitments, which often leads to a rise in their stock price.</p><p></p><p>If companies borrow less, we might see less work for finance teams. Or it could impact the kind of due diligence banks do on companies. The amount of debt a company has and its financial performance will matter a lot more. In that case, lawyers may push for additional security or financial covenants, so banks can be sure they get their money back.</p><p> </p><p><strong>Project Finance</strong></p><p></p><p>For a very long time, cheap credit has helped companies to fund projects and service their debt. But, as it becomes more expensive to borrow, companies may suffer from cash flow problems. That's especially true if they haven't accurately priced a rise in interest rates to their projections. So as a result, law firms will need to advise companies on how to refinance their debt or they could even see a fall in projects work.</p><p></p><p>For new projects, companies will want to hedge the risk of rising interest rates. That's where derivatives teams could step in. You wouldn't need to understand this in much detail, but in short, companies can enter interest rate swaps (where they swap a floating rate of interest for a fixed rate) or forwards (where they pre-determine the rate of interest) to protect themselves.</p><p></p><p>On the lender-side, banks may scrutinise companies with a lot of existing debt. One way of doing this could be to have their lawyers negotiate stricter terms into the loan documents. For example, they could impose covenants that restrict levels of debt or require security (collateral to back up a loan).</p><p></p><p><strong>Leveraged Finance </strong></p><p></p><p>The leveraged finance market is really busy at the moment. For example, investors have recently flocked to leveraged loans - loans to companies that already have a lot of debt - in preparation for a rise in interest rates. Leveraged loans have floating rates of interest. That means if interest rates increase, the rate of interest they pay to investors will also increase. In 2017, these were used to refinance a lot of debt and investment banks made a lot of money underwriting these loans.</p><p></p><p><strong>Structured Finance</strong></p><p></p><p>One of the biggest buyers of these leveraged loans are collateralised loan obligations. These are loans that are pre-packaged into bonds and sold to investors. Thanks to their record levels of demand, structured finance teams have also been exceptionally busy advising issuers.</p><p></p><p><strong>Private equity </strong></p><p></p><p>PE firms will have to pay more for loans, so will want to pay less for acquisition. For the last few years, PE firms have had a lot of negotiating power when it comes to borrowing money. Their lawyers have been able to push for 'cov-lite' loan agreements. These are loans with fewer protections for lenders. To give you a sense of how much it's grown - before 2007, about 30% of the leveraged loan market involved cov-lite deals, that figure is now around 70%. Thanks to these loose terms, PE firms have been able to pile debt onto companies. That could cause a lot of problems when interest rates increase.</p><p></p><p><strong>Restructuring and Insolvency</strong></p><p> </p><p>Companies with lots of debt could go bust or need to restructure. About 12% of US companies are said to be ‘zombies’, which means that their earnings aren’t enough to service interest payments, so a sharp rise in interest rates could put them on the brink of insolvency. So could mean more work for restructuring and insolvency teams.</p></blockquote><p></p>
[QUOTE="Jaysen, post: 190, member: 1"] [CENTER][B]The impact of interest rates on law firms - Part 2[/B] [/CENTER] [B]How do I connect commercial issues to law firms?[/B] First, it helps to understand that law firms are a service business. Clients pay law firms to handle their legal work and the legal work they do will vary between departments. We can simplify this so it’s easier to understand: Corporate lawyers advise clients who want to buy companies. Finance lawyers help clients raise money. Litigation lawyers help clients handle disputes. And so on. A news story could impact law firms in two ways. First, you can think about the impact on clients. Let’ s suppose your commercial issue leads to a rise in M&A activity. So now, you want to connect it to law firms. Let’s call your law firm Franklin & Associates. On a basic level: If corporate clients are doing more deals, they'll need more legal advice. That means corporate teams at Franklin & Associates will be busier. They may also be doing deals of a bigger value, so the law firm may see a boost in revenue. To go further, you could tailor your answer by comparing it to other law firms. For example, perhaps Franklin & Associates X can complete due diligence at a lower cost because of its investment in technology or a legal services centre. Maybe this’ll mean it’ll have an opportunity to advise on more deals. You could also discuss what the law firm can do to help clients. Suppose this time, we were talking about some kind of market crisis. You might suggest that Franklin & Associates help clients with their contingency plans. For example, it could develop draft wording for a new contract clause or keep clients up to date through regular research reports. This would help to protect clients from losing business in the region. You might also point out – after research – that some international clients have a lot of exposure to the market. So, Franklin & Associates may want to advise clients to scrutinise their contracts or limit the extent of any planned projects or supply chains in the market. You can also answer this question by thinking about the impact of a commercial issue on law firms. The issues can be a little harder to discuss, but you will have less trouble connecting the issue to a law firm. An upcoming example is the General Data Protection Regulation (“GDPR”), which places strict rules on the use of data for law firms and their clients. You may want to confirm why it applies – does Franklin & Associates have a presence in the EU? If not, does it represent clients in the EU, or hold data on EU clients? Then think about how the law firm could prepare for the GDPR, it may want to carry out an impact assessment or an audit of the firm’s contracts. Or it could hire an external specialist or invest in software tools – you can explain why accuracy is very important (think about the consequences of a failure to comply). [B]So, what’s the impact of interest rates on law firms?[/B] I’ll explain how a rise in interest rates tend to affect clients in various departments of a law firm. [B]Mergers & Acquisitions[/B] It’s possible to argue that M&A activity will fall if interest rates rise. That’s because it’ll become more expensive to fund acquisitions using debt. This will be an issue for leveraged buyouts - where companies use a lot of borrowed money to fund an acquisition. It could also affect the valuation of target companies. If borrowing costs eat into profit margins, acquirers may not be willing to pay as much. On the other hand, if companies are seen to be more affordable, the volume of M&A deals could increase. The valuations of companies have been rising in recent years, so an increase in interest rates may be a good thing. Even if this isn’t the case, many companies have built up cash reserves, also known as dry powder, so they're pretty resilient to a rise in interest rates. The economy is also doing well - that's why interest rates are increasing in the first place, so companies may opt to expand because they’re more confident in the state of the market. You can also nuance this argument by picking certain geographies (developed nations v emerging economies) or sectors (utility companies v tech companies). [B]The financial sector[/B] A rise in interest rates is generally good for the banking sector. Banks make more money from the difference between their portfolio of loans and investments and what they pay savers. This also applies to insurance companies and pension funds who have lots of cash to invest in securities, so they see a better return to cover their commitments, which often leads to a rise in their stock price. If companies borrow less, we might see less work for finance teams. Or it could impact the kind of due diligence banks do on companies. The amount of debt a company has and its financial performance will matter a lot more. In that case, lawyers may push for additional security or financial covenants, so banks can be sure they get their money back. [B]Project Finance[/B] For a very long time, cheap credit has helped companies to fund projects and service their debt. But, as it becomes more expensive to borrow, companies may suffer from cash flow problems. That's especially true if they haven't accurately priced a rise in interest rates to their projections. So as a result, law firms will need to advise companies on how to refinance their debt or they could even see a fall in projects work. For new projects, companies will want to hedge the risk of rising interest rates. That's where derivatives teams could step in. You wouldn't need to understand this in much detail, but in short, companies can enter interest rate swaps (where they swap a floating rate of interest for a fixed rate) or forwards (where they pre-determine the rate of interest) to protect themselves. On the lender-side, banks may scrutinise companies with a lot of existing debt. One way of doing this could be to have their lawyers negotiate stricter terms into the loan documents. For example, they could impose covenants that restrict levels of debt or require security (collateral to back up a loan). [B]Leveraged Finance [/B] The leveraged finance market is really busy at the moment. For example, investors have recently flocked to leveraged loans - loans to companies that already have a lot of debt - in preparation for a rise in interest rates. Leveraged loans have floating rates of interest. That means if interest rates increase, the rate of interest they pay to investors will also increase. In 2017, these were used to refinance a lot of debt and investment banks made a lot of money underwriting these loans. [B]Structured Finance[/B] One of the biggest buyers of these leveraged loans are collateralised loan obligations. These are loans that are pre-packaged into bonds and sold to investors. Thanks to their record levels of demand, structured finance teams have also been exceptionally busy advising issuers. [B]Private equity [/B] PE firms will have to pay more for loans, so will want to pay less for acquisition. For the last few years, PE firms have had a lot of negotiating power when it comes to borrowing money. Their lawyers have been able to push for 'cov-lite' loan agreements. These are loans with fewer protections for lenders. To give you a sense of how much it's grown - before 2007, about 30% of the leveraged loan market involved cov-lite deals, that figure is now around 70%. Thanks to these loose terms, PE firms have been able to pile debt onto companies. That could cause a lot of problems when interest rates increase. [B]Restructuring and Insolvency[/B] Companies with lots of debt could go bust or need to restructure. About 12% of US companies are said to be ‘zombies’, which means that their earnings aren’t enough to service interest payments, so a sharp rise in interest rates could put them on the brink of insolvency. So could mean more work for restructuring and insolvency teams. [/QUOTE]
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