Global loans recede amidst the COVID-19 crisis
The Covid-19 pandemic has put a halt to economic activity and will plunge the world economy into recession in 2020 according to the IMF. Issuance cycles are tracking the current paradigm and loans volume fluctuates as economic sentiment goes through peaks and troughs. The OECD Business Confidence G7M index for instance underlines the correlation between lending and confidence to do business.
APAC being the first region hit saw volume free falling from $73.6bn in December 2019 to $37.8bn in January 2020 and further contracting to $27.5bn in February 2020, the lowest APAC monthly volume since January 2017. As contagion gripped other world regions, Americas’ 6.3% year on year increase in January and February was quickly wiped out by a dismal performance in March where volume fell from $248.5bn to $221.4bn. With EMEA struggling as well, Q1 2020 global volume shrank by 15% compared to Q1 2019.
Corporates rush to draw on their revolvers
One of the key impacts of COVID-19 has been corporates tapping their revolvers (RCF). According to disclosed data 321 revolvers amounting to $201.0bn were drawn in 1Q 2020. Most of the revolvers drawn were from the Auto/Truck, Retail and Food & Beverages sectors with a 19.3%, 11.0%, 8.8% share respectively. General Motors drew $16bn in 1Q 2020, the largest so far this year, followed closely by Ford Motor with $15.4bn drawn.
Fixed income corporate debt outstanding totalling $22.67tr is a major source of concern. Critical sectors like Transportation, Oil & Gas and Leisure & Recreation are the ones to watch closely with $3.16tr of IG and $1.15tr leveraged/high yield (HY) debt coming due in addition to $862.4bn of RCFs in place. With companies like Delta Airlines, Petrobras and MGM Resorts already tapping their RCFs, the debt wall is bound to expand amidst risk of downgrade.
Fallen Angels shiver at potential borrowing cost hike
One of the casualties of the COVID-19 economic crisis will undeniably be corporates downgraded from investment grade (IG) to leveraged territory. 3Bs-rated corporate borrowers with $4.82tr of debt outstanding will be the prime candidates to tip into the fallen angel category.
Moving from IG to leveraged/HY will obviously impact future borrowing costs. For instance, US BBB- loans on average have been paying margins of 138bps and US BBB- bonds a spread of 225bps in the last 12 months. On the other hand, BB+ rated securities averaged out at 170bps and 260bps – more expensive for loans and bonds respectively. It is inevitable that the COVID-19 crisis will lead to more expensive borrowing cost for many corporates.
Leveraged Finance facing lockdown
From October 2019 to January 2020 margins fell continuously from 436bps to 334bps, triggering borrowers to tap the institutional market with $195.3bn of loans in January and February, up by 319% from a morose 2019. Whilst refinancing accounts for the lion share of transactions with 73.1%, new M&A related activity contributed to 20.6% of Jan-Feb volume.
The economic crisis unfolding will likely impact the market in various segments. CLOs constituents are likely to face rating downgrades which will impact on the overall CLO quality. Issuance for US CLOs saw a monthly volume contraction of 83% from February to March with activity falling from 69 to merely 14. Reduced CLO issuance will not only impact liquidity but will also leave risky assets on banks’ balance sheets.
Patience is key during distressed periods. 5 years post 2007 crisis, the institutional loans market witnessed revenue level higher than pre-crisis. Institutional loans in 2017 and 2018 saw unprecedented revenue which reached $7.6bn and $7.7bn respectively, nearly 3 times the level seen in 2007. Whilst increasing margin on loans, which rose to 472bps in March 2020, will deter borrowers in the short term, distressed companies whose business is impacted by the COVID-19 crisis will open opportunities for instance for sponsors with dry powder to use. Finally, the very low rate environment is likely to increase demand for leveraged credit in the future as investors will be searching for yield.