Loan markets react to Coronavirus shock

The economic disruption caused by the pandemic may be far from over, but there’s no sign of a meltdown in lending markets.

Highlights

• Even at the height of the coronavirus crisis in March, just 80 of the 35,000 funds sold in Europe were suspended, and very few asset managers were unable to meet commitments
• Post-2008 banking reforms are believed to have helped keep loan markets functioning for institutional clients
• But the longer and more severe the economic fallout from coronavirus, the more pressure will build on all borrowers

Reforms to shore up the banking system in the years since the 2008 financial crisis have cleared the way for recent massive interventions by governments and regulators, designed to keep corporate liquidity flowing and prevent the still-unfolding crisis from turning into another banking meltdown.

The International Monetary Fund’s managing director, Kristalina Georgieva, warned on 18 May that the global economy would take much longer to recover fully from the pandemic than had initially been expected, and many assets remain difficult to value amid plunging levels of transactions and fears of further virus outbreaks.

Meanwhile, a global survey of fund managers released by Bank of America in mid May found that investors were still anxious, with 52% fearing a second wave of the virus and 75% anticipating a U- or W-shaped recovery. This compares with just 10% expecting the V shape predicted earlier by Bank of England governor Andrew Bailey.

But there is a growing belief that the asset management and funds industry will emerge shaken but intact, having already coped with what should be the worst of the liquidity crunch.

Funds demonstrate their resilience

Fitch Ratings says that when asset prices were tumbling at the height of the coronavirus crisis in March, just 80 of the almost 35,000 funds sold in Europe were suspended, and very few asset managers were unable to meet their financial commitments or fulfil redemption requests.

Tanguy van de Werve, the director general of the European Fund and Asset Management Association, argued that the industry’s response to the crisis had weakened the case for tougher lending restrictions on asset managers.

“The next time the Financial Stability Board or European Central Bank call for asset managers to be subject to macroprudential supervision because they pose a risk to the financial system, we will be pointing to this crisis and arguing that our industry has proved its resilience so far,” he said.

Douglas Middleton, head of capital and balance sheet management at RBS International, says post-2008 banking reforms have helped to keep loan markets functioning for institutional clients such as fund and asset managers.

“The changes that banks have had to make since the global financial crisis, such as massively improving their capital ratios and liquidity coverage, and having loan-to-deposit ratios as a key metric have meant that the way banks fund themselves is now much stronger and less reliant on wholesale market funding,” he says.

The fact that any current issues in the loan markets are “an economy-led crisis rather than a bank-led crisis” mean that, compared with 2008, fewer corporate clients have felt the need to borrow money simply to shore up their balance sheets, according to Middleton.

“The changes that banks have had to make since the global financial crisis have meant that the way banks fund themselves is now much stronger and less reliant on wholesale market funding”

Douglas Middleton, head of capital and balance sheet management, RBS International

“That activity was much more prevalent in the global financial crisis when people were genuinely worried about banks,” he says. “Drawing down money on a loan and then placing that deposit back with the same bank is a negative carry trade for them, which largely doesn’t make sense.”

The funds sector itself “doesn’t necessarily show an awful lot of stress at investor level, so it’s more a matter of them making sure that their assets, and companies in their portfolios, have got cash and liquidity,” he adds.

Despite market rumours, there have been few signs of investors struggling to give injections of finance into early-life funds. “If you have a fully invested fund with no more liquidity to come into it and you have a liquidity crisis in one of the underlying entities, that is when it can be more challenging,” Middleton says.

“We have seen a few cases of people asking to borrow at fund level to support their portfolio entities, but in general the fund market that we face into has been strong, with minimal stress save in the real estate sector, where clearly there is a more direct impact.”

The shape of recovery

Liquidity pressure has so far been concentrated on sectors such as retail and hospitality, but will have knock-on effects as some rents go unpaid and supply chains feel the strain. Instead of a sharp V-shape, the recovery may end up resembling the Nike ‘swoosh’, Middleton says, with the sharp fall followed by a much slower climb back up.

Anna Layard-Liesching, a director in the institutional banking team at RBS International, agrees that market sentiment no longer expects a swift rebound, and entities such as pension funds and private equity funds are working to protect their assets from liquidity pressures. “But,” she adds, “they are also looking to the next opportunity to buy businesses as they come through the recession.

“If the recovery took the form of a sharp V, then we might have some people buying really cheaply and selling quickly. But in this case, there will be a steady pull-out, with buying and selling occurring over an extended period, rather than this activity occurring in a concentrated period of time,” she says.

The longer and more severe the economic fallout from coronavirus, the more pressure will build on all borrowers. But these problems may be even more acute for firms owned by private equity houses as they have faced extra hurdles in borrowing from heavily subsidised government lending schemes.

James Collis, a specialist finance lawyer at Squire Patton Boggs, says the 3,400 private equity portfolio companies in the UK have found it tougher than many other firms to get access to schemes such as the UK’s Coronavirus Large Business Interruption Loan Scheme (CLBILS).

One major obstacle has been the requirement for existing creditors to consent to new CLBILS loans, he says.

“In the leveraged finance structures supporting private equity portfolio companies, those creditors may well be diverse and account for multiple tiers of debt, each with a different view of the need for, and rights which should attach to, the CLBILS new money,” says Collis. “And this is not to mention their own price for such consent.”

Such restricted access to the government funding schemes will inevitably leave private equity portfolio companies more vulnerable if there are further waves of the pandemic or a slow search for a vaccine.

Adjusting to the new normal

Though there are testing times ahead, core relationship banks have been focused on providing coronavirus-linked liquidity facilities in their home markets.

While the bank market has been supportive of clients and their funding needs, it has had to be very disciplined during this period. Banks are taking strategic decisions around the geographies in which they operate and are being stricter in the allocation of capital and its associated returns. Higher volumes of shorter-term liquidity-related transactions and requests have dominated resource and pushed out timetables. The net effect of this is that the ‘new’ liquidity is less robust and has led to more inconsistent outcomes.

Borrowers should expect these conditions to endure throughout the remainder of 2020, though the impact will vary on a transaction-by-transaction basis. As they look towards their financing requirements and a form of ‘business as usual’, it will be crucial to maintain close dialogue with their lenders and have a good understanding of requirements.