Capital markets in the current climate

22 April 2020
As the Covid-19 pandemic continues to spread globally, it’s clear that all markets will be affected in some way. Here we ask Navita Yadav, Vistra’s Global Head for Capital Markets, to analyse the potential issues facing various areas of the industry in light of what we currently know.

While it’s hard to tell how the global economy will ultimately be affected by Covid-19, which areas of capital markets do you see as needing immediate focus and assessment?

The new coronavirus has become one of the biggest threats to the global economy and financial markets in living memory. From a market perspective, a key issue is the level of disruption caused as a result of government containment measures as they try to ‘flatten the curve’. 

Capital markets and structured finance encompass a variety of asset types that have already been directly affected by the outbreak. Uncertainty around the macro effects of the pandemic is likely to continue to add to market volatility for securitized products, especially with regard to liquidity and pricing.

Clearly, transactions backed by higher-risk assets such as leverage loans and high-yield bonds will be affected, as the obligors on the underlying assets struggle to pay or start breaching deal covenants. 

Where deals are backed by consumer-type assets, we have seen many governments put in place arrangements to support individuals. This support should allow people to continue paying their main obligations, such as mortgages, loans and rent, which means certain types of transactions may not become distressed or will become distressed more slowly.

The CMBS market has been hit by the pandemic as origination volumes dip and existing loans are placed into special servicing. On the CMBS origination side, there has been increased volatility in the past few weeks, with spreads initially expanding outward rapidly.

In the aviation industry, airlines are anticipating an impact even more severe than the 9/11 attacks or the 2008 global financial crisis. Many carriers are facing extreme financial pressures and making unprecedented capacity reductions in the face of strict travel restrictions imposed by more than 160 nations. Recently, Fitch Ratings placed 35 outstanding tranches of aviation asset-backed securities on a negative rating.

Central banks around the world, have already proactively intervened to calm markets and show commitment to using all possible measures. In its first emergency move since the recession in 2008, the US Federal Reserve recently cut interest rates to near zero in an attempt to bolster the US economy. It has also actively intervened in the repo market to add further liquidity. 

The Bank of Japan, issued an emergency statement signalling that it would inject liquidity into the market by increasing asset purchases. And the People’s Bank of China has also pumped more than US$240bn of liquidity into the financial system as a countermeasure to the virus. These measures will hopefully provide a measure of stability amid the turbulence.

Amid the unprecedented levels of uncertainty, how are ABS transactions reacting? 

Delinquencies in the fastest-growing segment of consumer debt market are increasing at a heightened pace with another wave of missed payments on marketplace loans expected. Margin calls have picked up as loan prices have declined, creating complications for CLO warehouses and challenges for managers who are being asked to post additional collateral or be forced to extend or liquidate the warehouse. 

Rating agencies continue to place more CLOs on ratings with a negative outlook, flagging deals with a growing exposure to loans facing a downgrade as the coronavirus drags on.

In numerous European countries, banks have started to offer payment holidays to private individuals and SMEs, so there will be an almost immediate impact on the performance of several ABS transactions and alternative lending platforms. Considering the fact that the latter have all been set up recently, with portfolios lacking spread in maturity, this may well lead to triggers. 

As the situation develops, more action may be required by central banks, regulators and governments.

As you say, more triggers will be hit and this will cause defaults – how can companies manage this right now? 

By conserving cash. Companies can also give out early disclosures on the specific impact on operations due to Covid-19, work with investors for the restructuring of payments, work with rating agencies on proper disclosures, and work with corporate service providers and trustees on restructuring and resolution plans. 

There is also an urgent need for constant monitoring, and flagging any early warning signs will help all participants in ABS transactions.

With travel bans almost everywhere, the aviation industry is in turmoil. What is happening to aviation financing in light of this, and how do you think the market will react in the coming year?

The majority of global carriers face cash run out within two months owing to the sudden halt in international flights. Large numbers of airlines have grounded most of their fleets and announced plans to lay off thousands of members of staff. Airline revenues globally in 2020 are set to decline by 44% compared with 2019.    

Plenty of carriers are also scaling back capital expenditure by deferring the purchase of new aircrafts. Cathay Pacific, for instance, is discussing deferrals with both Airbus and Boeing. 

Airlines are also asking leasing companies, which have grown rapidly over the past decades and now own around 50% of the global fleet, to show forbearance over payments. 

It’s clear that the aviation industry will feel the heat on cash generation and profitability for at least for the first half of 2020. If the outbreak persists beyond that, then we see a weaker recovery and the pressure will spill over till the year-end. It will be interesting to see what measures governments put in place to support this industry.

On the brighter side, one area of the aviation industry that has actually seen a bounce is the cargo sector, which has had an enormous logistical challenge in keeping supply chains moving for essential supplies.
The recovery of the business and leisure aviation segments will depend on a number of factors, particularly the length of time social distancing is required. Some airlines may also be nationalised by their home governments. This may come in the form of financial support with governments having controlling interests in the airline.  

India is enforcing one of the strictest lockdowns globally. As you are based there, what consequences do you think this will have for wider capital markets?

India was among the first countries to impose a complete nationwide lockdown for 21 days, ordering 1.3 billion people to stay at home to slow the spread of the coronavirus and prevent an imminent public heath disaster. 

The country was already reeling under a demand depression and lowering of industrial output and profits, all of which has been happening together for several quarters now. A supply-side constraint could deliver a big blow, jeopardising growth prospects. 

The lockdown has led to further postponement of investment activity across all sectors in India. Some of the short-term direct impacts include a near freeze in debt issuances and securitisation transactions, FPI outflows and many fund houses having postponed capex activity with investors deferring their plans. On March 26, India’s Finance Minister announced a $23bn package aimed at cushioning the disruption. 

Yet we are already seeing missed payments in debt issuances and companies resorting to force majeure clauses in documentation. It now remains to be seen how rating agency action and noteholders’ responses in calling the event of default and the subsequent unfolding of enforcement measures takes shape, or whether they allow a moratorium to the issuers during the Covid-19 crisis. Either way, creation of resolution plans and restructuring of payments seem imminent.

Finally, can you highlight how Vistra is reacting to the pandemic? How are you ensuring that services and operations continue now and adapt for the future?

We truly appreciate the healthcare workers, local communities and governments who are on the frontline, working to contain this pandemic. At Vistra, we are vigilantly monitoring and taking proactive steps to safeguard all our employees and clients while complying with government and healthcare advice.  

Together with our clients, our offices and branches also face lockdown. However, we are working behind the scenes to ensure that our service delivery remains uninterrupted.  Our business continuity plan is in place, having been activated in mid-March. All our offices mobilised incident management teams and swiftly implemented working-from-home procedures, which enable all our Capital Markets staff to continue to serve our clients without disruption, while ensuring the safety of our colleagues. 

Client confidentiality and data security continues to be our priority and measures have been taken to ensure these. 

As corporate service providers and responsible corporate trustees and agents, Vistra Capital Markets has stepped up monitoring of deals to track any triggers that may get hit so that we are well-positioned to not only deliver effective service, but also to add value to the stakeholders of the transaction.

No one can predict when or how this pandemic will end and what the world will look like afterwards. What we can all do is be vigilant, work together, and follow the health and safety guidelines issued by our respective local governments. Let precaution not panic be the mantra.