SPAC frenzy is unsustainable warns DBRS Morningstar

But the credit ratings firm says some banks will handle the fallout better than others

SPAC frenzy is unsustainable warns DBRS Morningstar
Steve Randall

There has been a lot of interest recently in special purpose acquisition companies (SPACs) but can the frenzy endure?

Not according to a report from credit ratings firm DBRS Morningstar which is warning of the risk to investors from a potential bubble due to an exponential rise of the blank cheque companies during the last year which is already being dwarfed by the continued frenzy in 2021.

One of the latest headline-grabbing stories is the proposed merger of former co-working space darling WeWork with BowX Acquisition. This tie-up with a SPAC comes in the wake of WeWork’s failed IPO in 2019 due to investor concern about its financial stability.

These forms of investment have been around since the 1990s, but their sharp recent growth is driving the concerns. Their proliferation in North America is about to be joined by a new focus on their potential in Europe and Asia. 

Investor safeguards

In its commentary, DBRS Morningstar calls for widespread adoption of investor safeguards as valuations for SPACs reach eyewatering highs.

“Overall, we view the current rapid growth in SPACs as unsustainable, but banks with diversified capital markets business models should be able to capture business through traditional initial public offerings and merger and acquisitions to help offset any lost SPAC-related revenues,” said Cheryl Saldanha, assistant VP of the firm’s Global Financial Institutions Group.

DBRS Morningstar believes that protections that aligns retail investors’ interests with those of sponsors could make SPACS into a more attractive investment opportunity.

Its commentary highlights that there are some positives of SPACs including improving access to capital for businesses during times of market volatility and providing an element of stability for financial institutions’ revenues.

But because investments in these companies are “blind” there is a high level of trust placed by investors in the sponsors who aim to find the right acquisition with growth potential.

Celebrity-fuelled bubble

However, the report warns that the participation of celebrities, politicians, and famous investors “may point to a bubble.”

Earlier this month, the SEC issued a warning that investors should not participate in SPAC investments just because celebrities are involved.

“Celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss.  It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment,” the SEC warning stated.