A mix of corporate and sovereign issuers tapped credit markets around the globe in order to survive during the pandemic shock. Funding cost and capital structures for corporates were placed on the back burner as the very existence of companies came into question.
The uncertainty that gripped credit markets during the lockdown period meant that funding costs shot up as willing investors became ever more averse to lending during a period upon which visibility was opaque at best. Intuitevely, the hardest hit were corporates on the lower end of the credit ladder. The common practice in the funding world has always been centred on credit risk; that is, what is the probability of default? Naturally, the higher the risk of default, the higher the expected cost of capital. Indeed, in a matter of weeks, observed yields for sub-investment grade debt went from a low point at 2.60 per cent during the end of February which then shot up to the highest at c. 9.60 per cent by the end of March.
The jump of seven per cent over a month shows the jaw dropping scale of the problem that credit markets were envisioning at that point. Prudent investors tapping creditworthy issuers with solid business models could reap the benefits for their long term financial goals.
For corporates in the lower end of the credit spectrum, this was a curse as the shutdown in operations meant that there was no incoming cash flows, but at the same time there was an outpour of cash in order to meet obligations of all sorts. Corporates domiciled in economically strong nations tapped government assistance via grants and cheap loans to ensure survival. In a sense, corporates in these regions were fortunate to have the required assistance not only in the short term but also in the medium term. This came on the back of commitments brought forward by governments around the world to ensure to do whatever it takes to keep their respective labour market stable and avert mass unemployment.
Governments in the developed space understood that the private sector remains a key contributor to economic growth. This meant that they provided unprecedented support to overcome the problem. This calmed markets, however, some of the hardest hit nations were already heavily burdened with debt before the pandemic shock. The grants and assistance, such as furlough schemes all meant that nations had to borrow even more to the detriment of their financial strength.
On an upbeat note, central banks around the globe all cut rates in synch with the expected shock of the pandemic and boosted money supply which resulted in significantly low interest rate levels for highly rated debt.
European corporates in the €12tn investment grade space was yielding c. 0 per cent during February which then increased to 0.70 per cent. Companies in the top tier of the credit spectrum did not experience the same gyrations as lower graded peers. Indeed, companies in defensive sectors like consumer staples, utilities, technology and telecommunication all tapped markets as investor preference shifted strongly towards these ‘essential’ sectors. This meant lower than average yields for these sectors, whilst companies within other economically-sensitive sectors had to fund their operations at a higher cost in order to boost their working capital.
Disclaimer: This article was issued by Jesmar Halliday, CFA, investment manager at Calamatta Cuschieri. For more information visit www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.