Covid-19 had an immediate impact on all business sectors around the world. Some have thrived, but the majority have been adversely affected. What have been the most pressing challenges for capital markets?
While the damage caused by the pandemic isn’t confined to select pockets of businesses, it’s clear that some have suffered the most and continue to suffer — with aviation, retail, hospitality, financial services, real estate and automotive some of the hardest hit.
On the other hand, some sectors like technology, healthcare and pharmaceuticals have flourished. Amazon, for instance, posted the biggest profit in its 26 year history as online sales and its lucrative business supporting third-party merchants surged during the pandemic.
It’s difficult to quantify precisely how much global capital markets will be affected by the pandemic. What we have seen, however, is that structured finance and capital markets encompass a variety of asset types that have been directly affected by the outbreak.
In Europe, we saw the lowest ever issuance of securitized products in the first half of 2020, with only €79.4bn being issued. This is 8% lower than in the first half of 2013, previously the lowest half-year issuance on record, and 15% lower than in the first half of 2019.
Securitization secondary markets have suffered disproportionate reductions in liquidity due to central bank support. And uncertainty around the macro effects of the pandemic is likely to continue to add to market volatility for securitized products, especially on liquidity and pricing.
If we look at the lessons learned from the financial crisis of 2008 and the eurozone sovereign debt crisis, we can see that well-designed asset-backed securities (ABS) are resilient under stressed circumstances. However, while government forbearance may be a necessary stopgap measure, the resulting frictions on cash flow with respect to underlying assets may make financing these assets more challenging and, as a result, may have longer-term repercussions on funding in the real economy.
A number of heavily indebted businesses went to the wall quickly — did Covid simply expose the weaknesses that already existed in companies such as these?
The pandemic caught everyone by surprise. But yes, the imposed shuttering has exposed the balance-sheet frailties caused by poor fiscal choices made by business executives over the past decade. The debt had been readily available for real estate companies, for instance, so many found themselves in high debt, which has been accentuated by cash flows drying up during the pandemic. As a result, some had to resort to bankruptcy.
We saw how some highly indebted companies found it difficult to service interest payments on loans, and it was only down to governments offering moratoria on interest payments that helped them survive. Indeed, many had no option but to go hat in hand to the government, seeking assistance.
With fragile balance sheets, shuttered businesses are now facing an existential threat. Most of the companies in line to get taxpayer money don’t have any rainy-day fiscal buffers to absorb economic shocks from unpredictable events.
What’s more, the debt of global economies was already at an all-time high, and Covid has exacerbated that. We are living in a debt world. To solve the problem of debt, we are doling out more debt — it’s counterintuitive, but that’s the reality of the world today.
And what of non-dilutive short-term liquidity, CLOs and the like — are any trends emerging?
There has been an increase in trading activity in the loan markets as investment managers proactively look to take advantage of the current market volatility. This will be beneficial for trading activity tariffs in loans administration.
Prices of CLOs and other debt products are well below market value right now, and this is where big hedge funds will take advantage, and we should see huge returns. CLO managers will push for the ability to either provide companies with rescue financing or increased flexibility to receive equity in a workout situation in order to be able to participate in future reorganisations.
The dynamic with non-CLO lenders could also be that they would pick up distressed loans and drive the restructuring and the economics of the restructured debt.
From where we’re sitting, while the pandemic has been a hugely active period, EMEA CLOs seem to have held up reasonably well. That said, while issuance has continued, it’s definitely off compared to where it was last year. The most significant change has been the timelines involved in getting deals done. Whereas before, you could go from picking up a first draft document through to pricing in six weeks or longer, now we’re looking at a fortnight, maybe even less.
This extract was taken from a full-length Q&A with Navita Yadav. To read the full report, click here.