COVID-19: Market Update for Centrus Clients
In light of the current market volatility created by the rapidly evolving global response to the COVID-19 pandemic, Centrus is publishing a market update for our clients. The market update tracks the key developments in the main funding markets relevant to our clients as well as offering insights from our experience of supporting clients through these challenging markets.
In general, the banking market is continuing to support existing clients while being more selective on new deals where the picture on a name by name and sector by sector basis has been very dynamic.
Bank’s balance sheets are still being tested due to a combination of factors, amongst them a spike in demand from corporates for immediate liquidity as well as an increase in their own funding costs. More importantly, there is still deep uncertainty on the future of several sectors to which banks are heavily exposed, with the recent oil price collapse raising the prospect of future write downs in the energy sector, where we are already seeing certain banks stalling approvals or asking for further structural protections. In the past few days, we have even seen a large far-eastern bank cancelling several of its commitments globally.
On the other hand, several banks are providing new facilities for existing relationships and there is a recognition that this period of turmoil can be an opportune time to expand the product base with current clients. There are also pockets of bank liquidity open to new opportunities, including (but not limited to) Japanese and US banks which can see lending in GBP favourably (but not necessarily in EUR). For instance, despite difficult market conditions Centrus recently introduced a new Japanese bank to one of our UK regulated utility clients.
In Europe, loan volumes have increased as a result of the capital markets pricing gapping out. Loan margins have recently widened but corporates who were early movers have generally been rewarded with more competitive levels. As a result of the tight levels earlier on in the crisis, European banks have been able to price out US and Asian banks in EUR loans, offering relationship borrowers cheaper pricing.
At the same time, banks that were looking to exit some of their exposures preCOVID-19 have put their sell downs on hold as the pricing on offer undermines the original business case for exit.
From a derivatives perspective, we have seen an increase in charges across the board as well as in some cases a reduction in capacity. We recently saw a global UK bank refuse to incur new market trades above a certain size as a company wide policy.
We are working with several clients on thier liquidity and business planning strategies and expect the number of waiver requests made to the banking sector (as well as the number of consent solicitations) to increase, particularly in transport and other COVID-19 exposed sectors.
Overall, we are working on series of debt and hedging transactions at the moment and we see the banks still offering support to existing (and sometimes new) clients. Pricing is still a key consideration but it has moved in the right direction since the peaks in mid-March. Still, there is a much stronger focus on sector than before – whilst it is estimated that on average pricing has widened anything from 25-50bps, for more affected credits this could be over 100bps.
Putting this into context, two of our clients, both A rated credits which would have priced similarly in the bank market a few months ago are currently looking at 100-150bps differential in pricing as one is in the more stable transport infrastructure space with c.50% contracted revenues whilst the other is in the oil & gas sector. This average pricing differential however, hides the often large discrepancies on pricing from different banks to the same deal.
Public Bond Market
Some semblance of normality has returned to public bond markets in recent weeks with the alleviation of underlying yields and spreads volatility underpinned by an abundance of liquidity and central bank support. In addition to being ratings sensitive, investors have become very sector sensitive, with sectors not impacted by COVID-19 faring better across markets. Transactions have generally been well supported with new issuance premiums being set deliberately wide for initial guidance before tightening on final pricing.
Testament to this was the record breaking issuance of circa EUR 40bn issued by European corporates in the week ahead of Easter. Highly-rated, defensive names such as pharma company Sanofi (A1/AA), utilities including EnBW (A3/A-) and Naturgy (BBB/BBB) or telecoms group Telstra (A2/A-) have typified EUR primary issuance. But as of late, a number of more cyclical or COVID-19 exposed credits have come to market with American Honda (A3/A) and Toyota Australia (A1/AA-) both pricing dual tranche transactions. Nonetheless, as exemplified by their strong investment grade profile; ratings and investor familiarity remain of the utmost importance when pricing transactions in euros. Perhaps demonstrating this most forcefully was Swedish alarm company, Verisure (B2/B) as it priced an upsized EUR 200m 5-year FRN, the first high yield deal in almost 7 weeks.
In comparison, the depth of the US bond markets is clear for all to see with a record run-rate of issuance (USD 126bn up to 16th April – more than double the entire volume of issuance in April 2019). Issuers, in contrast to Europe, have come from across the credit spectrum with highly exposed COVID-19 names such as hotel chain Marriott International (Baa3/BBB) more than 15x oversusbscribed as it raised USD 1.6bn. Similarly, General Electric (Baa1/BBB+) raised USD 6bn across 4-tranches as it sought to raise funding ahead of a possible downgrade. However, both issuers had to pay handsomely with Marriott pricing its new issuance some 400bps wider than pre-COVID levels and GE circa 150-200bps.
The deluge of issuance in the United States has been dominated by domestic names but BMW (A2/A) has proven to be one European issuer to execute a USD trade. The German auto priced a USD 4bn triple-tranche early in April but may yet be followed by other European issuers. USD pricing for European issuers can now be seen 20-40bps inside where an equivalent EUR deal would price, whilst the additional depth of the US markets at longer tenors (10-years plus) could prove attractive.
In contrast the sterling primary market has been somewhat subdued with circa GBP 2.3bn of issuance since the start of April. Well established and trusted names such as Thames Water (Baa1/BBB+), Tesco (Baa3/BBB-), National Grid (A3/A-) and numerous housing associations have ensured a consistent flow of issuance. That Tesco’s GBP 450m 2030 deal attracted books of more than GBP 4.4bn demonstrates that the sterling investors are open for business. However, issuance is likely to be confined to domestic issuers or those with significant GBP exposure until relative value versus EUR or USD issuance proves more attractive.
Private Institutional Market
After reopening in late March, private placement (“PP”) activity picked up with decent volumes and spreads tightening from 300s levels into 200s for defensive names, lead largely by utilities. The vast majority of issuance was in USD for US issuers with issuance mainly from defensive names, with more COVID-19 impacted names such as Delta Airlines issuing at significantly higher spreads. The sterling PP market has also reopened with housing, ceramic and chemical companies securing deals.
The PP market has a lot of dry powder ready to support clients but price discovery is a key issue in light of volatility in public bond and swap markets. As such the PP market is still lagging behind public markets showing slower spread tightening and we expect this trend to continue as activity picks up and general spread tightening finds it’s way into private markets. Late March/early April issuance was almost entirely USD-denominated, e.g:
- Delta Airlines priced an EETC Class B and Class C (BBB and BBB-) at rates between 7-10% depending on tranche and
- Dominion Energy North Carolina, BBB+, opened the issuance for 10-and 30- year at levels around UST+330bps.
- South Jersey Gas, viewed as NAIC-1 (A1/A-) issued a multi tranche: USD 150m 10-year bullet, with a 3.28% coupon, at +265bps; USD 250m 30-year bullet, with a 3.93% coupon, at +265bps; USD 125m 30-year bullet, with a 3.98% coupon, at +270bps (October delay).
After the Easter break several more USD-denominated utilities came to the USPP market:
- Pennsylvania Electric Co, viewed as an NAIC-2 (Baa1/BBB). The company priced its first USPP across two tranches: USD 125m 12-year bullet, with a 3.61% coupon, at +285bps; and USD 125m 15-year bullet, with a 71% coupon, at +295bps.
- Portland General Electric, NAIC-1 (A1/A-). The deal was launched as USD 200m of FMB, split into 5- and 10-year tenors and priced at UST +250- 275bps.
- Centrus opened the sterling PP market with a GBP 45m 30-year private placement for Your Housing Group (A), a North of England housing association
Mid-April saw two UK corporates tapping the sterling PP market (a Ceramics maker and a Chemicals company).
In the last week the trend of US utilities in energy, water and transmission coming to the market has continued with further issuance from Aqua Pennsylvania, Essential Utilities Michigan Gas Utilities Corp and Minnesota Energy Resources Corp and American Transmission Co LLC.
Interest Rate & Inflation Market
Long dated Gilt yields and RPI breakeven levels rose by as much as 80bps and 55bps just prior to the announcement of UK COVID-19 lockdown measures on the 23rd March, having peaked on the 18th March. Levels largely recovered in the week following that and have since fallen below pre-COVID levels.
This has largely been the result of significant monetary stimulus provided by the Bank of England in the form of a £200bn increase in its Asset Purchase Facility to £645bn, alongside similar moves by the Federeal Reserve and European Central Bank.
More recently the fall of prices to negative levels has captured financial headlines and alongside falling consumer demand, fed through to a CPI print of 1.5% YoY and lower near-term inflation expectations. On long term inflation, forward inflation levels have fallen with the 20Y RPI Zero Coupon reducing by over 20bps over March, notably the rate fell from 3.1% on 25/02 to 2.8% on 25/03, with a low of 2.7% on the 19/03. Towards the end of the month, the rate has shown a gradual growth reaching 2.92% to then follow an approximately steady path over the month of April.
An important point that inflation markets have noted is the further delay on the RPI (to CPIH) consultation with deadline for responses pushed back to August. This will likely mean HMT’s response will come at the earliest in September/October this year.
In foreign exchange markets, GBP weakened significantly following the outbreak of COVID-19, falling in value against the USD and EUR by as much as 11-12% over the month. Since mid-March, GBP has strengthened 3% and 8% against the EUR and USD respectively.
GBP RPI Swap curve is very steep in the near term and inverted after year 10 (while it was almost flat as of a year ago) presenting an oppotunity to fix (“sell”) inflation in the near term. Locking in 4/5yr RPI at 3.00%-3.20% presents a potential opportunity to enhance cash yield for certain assets with inflation linked exposure in the neat term.
The immediate impact of COVID-19 on ratings is becoming evident as agencies have now had time to fully assess exposure across sectors and individual credits.
No industry is fully insulated from the effects of COVID-19 but some are more heavily exposed. Aviation and demand driven sectors such as hotels and leisure and retail have been significantly impacted as consumers are confined to their homes by the virus. In many instances, COVID-19 has simply exacerbated existing problems and further undermined financial weakness.
The unprecedented fall in demand for non-staple goods and services has seen the contagion of reducing credit quality spread across multiple industries including Aerospace, Automotive and Oil & Gas. Moody’s has downgraded a number of high profile names in recent weeks including Boeing (Baa2/Negative), Rolls Royce (Baa3/Negative), BMW (A2/Under Review), Schlumberger (A2/Negative) and Repsol (Baa2/Negative).
This trend has been exemplified by the rating actions taken by the agencies. In Europe, Fitch has reviewed the ratings of 108 corporates and downgraded 33. Of the 15 issuers across gaming, lodging and leisure, airlines and retail; 11 were downgraded including British Airways and Marks and Spencer to sub-investment grade BB+ ratings.
As the chart below outlines, the overwhelming negative ratings impact has been seen in the sub-investment grade space where financial robustness was already weakest. In contrast, over 60% of investment grade companies had their ratings affirmed.
In addition to the review of its corporate ratings, Fitch has also finalised the review of its EMEA airports portfolio. Despite the impact on demand and worsening economic backdrop, unlike S&P only a few weeks earlier, Fitch did not make wholesale downgrades of its portfolio. Heathrow’s A-/Stable rating on its Class A tranche of debt was affirmed, citing that its hub status and associated capacity constraints would underpin a quicker recovery versus peers. Other dominant airports and operators such as Gatwick (BBB+/Stable) and Aena (A/Stable) had their ratings affirmed thanks to its existing ratings headroom and cash flow resilience. Nonetheless, there were some negative rating actions taken with one- notch downgrades for Aeroports de Paris (A/Stable), Copenhagen (BBB/WatchNeg) and Moscow Domodedovo (BB/Neg); whilst both Brussels Airport (BBB+) and Manchester Airport Group (BBB+) had their outlooks revised to negative.
Resilience to COVID-19 is probably best exemplified by regulated utilities. In its review of the sector, S&P did not downgrade one entity and revised four ratings to outlook negative and CreditWatch negative respectively. The 13% of its ratings that have a negative bias reflects greater exposure to merchant power or more cyclical risks, as well as tighter headroom versus existing credit metrics. S&P does note the potential rise of delinquent bills or bad debts as a concern, but is optimistic that the sector has the financial flexibility to withstand any temporary working capital constraints. Additionally, the announcement by a number of companies of a dividend cut or cancellation to preserve liquidity has been seen as credit positive.
Following rating downgrades in March by major rating agencies and with no major financial support package released in the UK and Europe, airlines and airports remain exposed with weak and uncertain outlook.
In the UK, the industry can access COVID-19 Job Retention Scheme, and for companies that were in sound financial health (i.e. with investment grade metrics) as of 1st March 2020, COVID-19 Corporate Finance Facility (CCFF). Easyjet tapped into the CCFF issuing GBP 600m of Commercial Paper on 6th April 2020.
Public bus operations
Following relatively quick action to provide an emergency financial support package to rail operators, the Department for Transport (DfT) announced a GBP 400m support package, the COVID-19 Bus Services Support Grant, on 2nd April 2020 in order for the bus operators in England to keep services running at 50% of normal levels to provide enough capacity for key workers and people who need to travel for work or shopping for essentials. The package includes protection of GBP 200m of existing planned capex investment.
Scotland announced its support package for bus operators on 25th March 2020 where concessionary travel reimbursement and bus service operator grant payments will be maintained at the levels forecasted prior to the impact of COVID- 19 – typically over £GBP 260million per annum. A similar arrangement for financial assistance is in place in Wales amounting upto GBP 69m.
These support packages are in addition to the UK Government’s other major programs which include COVID-19 Job Retention Scheme, Business Interruption Loan Scheme and COVID-19 Corporate Finance Facility.
A decisive action with respect to providing financial support to national rail and bus operations in UK (and Europe) means major rail and bus operators such as Go- Ahead, National Express, Stagecoach and FirstGroup have avoided rating downgrades (although some remain on negative watch). Thier share prices have been recovering significantly since the lows in mid-March 2020.
Urban light rail and metro services
UK Government is yet to provide specific financial package to support urban light rail and metro services such as London Underground, Manchester Metrolink, Tyne and Wear Metro and Liverpool’s Merseyrail. We understand that the DfT and urban metro and light rail operators are in close discussions to come up with appropriate level and terms of the financial support.
Ferry travel between mainland UK and Ireland and UK and Europe has been reduced to essential journeys which has meant significant reduction in revenues for the sector. Operators are seeking government support with no major financial package being announced for the sector to date.
High Speed Rail
High speed rail and related infrastructure across Europe could experience sector tailwinds as economies emerge out of COVID-19. On 16th April, DfT issued a formal notice to procced into design and construction phase for HS2. Europe will likely continue on its path of increasing private sector competition in the rail sector. With ever-increasing support for rail over road and air travel due to climate change concerns and, added to that, economic benefits of investing in infrastructure, high speed rail could experience strong investment in the coming decade.
How can we help?
The Centrus team are actively advising clients every day in this market through a series of financing, ratings advisory and hedging engagements. At the same time, we are continuously engaging with a large variety of capital providers both banks and investors as well as credit rating agencies.
Our assessment is that client’s priorities are to maintain access to sufficient short- term liquidity while ensuring capital structures are robust for a potentially difficult period of business and market volatility.
We have extensive experience of providing support and advice to clients and offer a range of services, to support clients from initial preparation and readiness (e.g. strategic options review, liquidity assessments, stress testing) through to advising on and implementing liquidity solutions and restructuring options.
Report published 24th April 2020.