HOW COVID-19 IS AFFECTING CORPORATE FINANCING AND OVERVIEW OF THE IMPLEMENTED SOLUTIONS
Financing has always been a crucial matter to corporates regardless the sector they operate in. Notwithstanding, the current situation on debt capital markets, mostly due to the worldwide spread of Covid-19, is making it significantly more troubling than usual, leading companies to consider alternative solutions.
Primary Market Effects
On the primary market, companies are struggling to issue, failing in injecting fresh money into their business, or even roll their outstanding debt close to maturity. An example is given by the Commercial Paper market, always considered a flexible and low-cost solution for many companies, despite their credit rating. Nowadays, issuers, even those with IG status, have seen their financing costs more than tripled, now sitting at levels close to those registered during the global financial crisis. Looking at longer-term products, such as Corporate Bonds, the current situation is only worse, if possible. Indeed, putting aside a few exceptions, the market is pretty much dry for HY and non-rated issuers, and is very small for those who stand in between the IG and HY status, as investors fear a possible downgrade. In these times of uncertainty, most of issuance volumes come for highly rated issuers, benefiting from a credit profile that makes them eligible to Central Banks’ Purchase Programs.
Secondary Market Effects
On the secondary market, severe outflows have been seen lately on Corporate Bonds and CPs, hitting prices and putting a remarkable pressure on yield curves. On one hand, corporate investors are trying to keep their liquidity high by either selling their long-term positions or avoiding to roll those that are about to mature. On the other, institutional investors are not only willing to build a safety cushion with their cash but they are also coping with the constraints imposed by their investment policy. As a matter of fact, over the last few weeks, downgrades by the main credit rating agencies have led to a series of fallen angels, i.e. companies who have lost their IG status, flooding the market with junk bonds. In the US, the market has seen an increase in fallen angels of about $120bn, while in Europe, it is expected to be around €61bn, considering non-financial companies only, with €38bn and €110bn in a bullish and bearish cases, respectively. As a consequence, as most institutional investors have limits on junk issuers, they had to sell quickly their position making prices plummet.
Having stated the problems, how are companies dealing with them? Their main concern is related to debt repayment when investors are not willing to roll their positions or to take on new investments. Therefore, at first, the immediate solution to this problem has been reverting to their Banks in order to use their credit facilities, ready to use but very expensive compared to capital market solutions. Later on, they notably lifted their yield curve so as to attract new funds without any success, in most cases.
As a consequence, other solutions have been implemented by Central Banks. In the US, the Fed has lowered its Fed funds target rate by 100bp to a range of 0-0.25%. Moreover, a new round of Quantitative Easing has started with securities purchases of at least $700 bn that will take place over the next months. In addition to this, a series of facilities has been put in place: the Commercial Paper Funding Facility (CPFF), allowing the Fed to buy on the secondary market, through a SPV, CPs issued by highly-rated companies, at least A1-P1-F1, and one-time purchase of CPs issued by issuers with at least A2-P2-F2 rating; the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF) to buy bonds issued by eligible counterparties, respecting specific rating requirements, with maximum maturity of 4 years for the former and 5 years for the latter.
In the UK, the Bank of England has put in place many measures to support all market actors. Specifically, the cut of its interest rate to 0.1%, that will reduce costs in funding for banks, businesses and households; the Covid Corporate Financing Facility (CCFF), that supports firms’ liquidity by purchasing CPs issued by those rated at least A3-P3-F3, the Coronavirus Business Interruption Loan Scheme, that provides SMEs with access to government-backed finance, with a guarantee up to 80%, for a maximum of GBP 5 million.
As far as the Eurozone is concerned, the ECB has expanded its existing QE, already at €20bn, by adding €120bn. Moreover, a new Pandemic Emergency Purchase Program (PEPP) has been put in place, that will allow the ECB, through its Local Central Banks, to buy marketable debt instruments, issued by companies with a minimum rating of A2-P2-F3, that have an initial maturity of 365/366 days or less and a minimum remaining maturity of at least 28 days.
In Sweden, the Riksbank has started to buy on auction base CPs issued by non-financial companies up to a total amount SEK 300bn. The papers need to have a residual maturity of up to three months and to be issued by companies with at least A3-P3-F3 rating. Moreover, the Bank has recently decided to buy Municipal Bonds for SEK 15bn.
In addition to these measures at European level, each country is implementing further solutions. In France, the Government has enacted a guarantee scheme to support bank financing to businesses, dealing not only with pre-existing loans but also new ones providing guarantees between 70% and 90% depending on the size of the company. In Germany, two main programs have been put in place: KfW-Unternehmerkredit, for established companies, and ERP-Gründerkredit-Universell, for those that have been in existence for less than five years. They will be channeled through local banks and will be equivalent to €200bn. As for SMEs, further €50bn have been put aside to support their business. In Italy, the Government has enforced a decree that will guarantee loans for SMEs and self-employed up to 90%, for a total amount of €200bn. Moreover, it has implemented a protection for those listed companies showing a weak stock market situation, that are considered strategic in the energy, defense and telecommunication sectors, in order to avoid foreign holdings overcoming the threshold of 10%. In Spain, the Government has activated a publicly guaranteed credit line through the ICO for a total amount of €100bn that, at least in the first round, will be provided through the five largest Spanish banks. The State will provide guarantees up to 70% and 80% depending on the size of the company. Finally, the Swedish Government has arranged a measure to guarantee up to 70% of the new loans provided by banks, allowing companies to borrow up to SEK 75 million in order to relieve the pressure on their liquidity.
As we have seen, Government and Central Banks’ responses has been quick, and the measures announced historical. Nevertheless, the completion of such actions turns out to be more complicated than first stated and some concerns are arising.
At the European Level, the response keeps adjusting as the effect of the crisis on the economy and on companies’ balance sheet are unfolding. We had the proof of that on 22nd of April when the Central Bank agreed to start accepting non-investment grade debt as collateral, on the path to follow the Fed and buy higher-quality junk bonds to partially limit the effect of possible fallen angels, as mentioned above. In the meantime, EU leaders are still discussing a possible 2 trillion-euro ($2.2 trillion) rescue plan for the region as an estimate of private-sector activity in the euro area plunged to just 13.5 from 29.7 in March (IHS Markit).
Concerning national intervention to guarantee liquidity to businesses, doubts are still on the table in some countries as most of measures taken are channeled through private banks. This uncertainty takes place at several levels, starting at the documentation to be drafted and going up the inequality of loans distribution between banks or between businesses. Indeed, in some countries, the implementation characteristics has led to favor specific banks and types of business, making it harder for an entire part of the economy to access the first wave of liquidity.
– The Wall Street Journal
– Federal Reserve
– Bank of England