We are in the midst of a global coronavirus pandemic, with worldwide GDP contracting substantially, creating a phenomenon of corporations issuing record amounts of new indebtedness. Les Nemethy and Sergey Glekov examine activity on corporate bond and loan markets, as well as the motivation for borrowers to take on new indebtedness.
Central bank stimulus has made the corporate bond market an attractive fund-raising tool for companies. The U.S. Federal Reserve as well as the European Central Bank (through its Pandemic Emergency Purchase Program) have included corporate bonds in their asset purchase schemes, helping to drive down yields, making corporate debt cheaper than ever.
In the United States, investment grade-rated firms issued USD 261.8 billion of new bonds in April 2020 alone, almost three times higher than in April 2019, according to the Securities Industry and Financial Markets Association.
The Fed programs were expanded on April 9 to include certain junk bonds. As a result, the junk bond market also saw a flood of new issuance in April, for example Yum Brands, owner of KFC and Pizza Hut, and cinema operators AMC, companies struggling to maintain liquidity due to a collapse in revenues.
The data from Europe mirrors the situation in the United States: European investment grade-rated companies raised USD 83.2 bln in April 2020, reaching levels not seen since 2009, according to newswire Reuters.
U.S. corporate lending (commercial and industrial loans) skyrocketed in March and April of 2020.
Corporate loans typically increase when the economy is thriving. The current surge is due to companies striving to maintain liquidity due to the COVID-19 outbreak. Similarly, data from Europe shows that volumes of new euro-denominated revolving loans and overdraft facilities to non-financial corporations increased substantially in March.
The current surge in corporate lending in the euro area is also supported by very low interest rates on new euro-denominated loans (revolving loans and overdrafts) to euro area non-financial corporations, lending rates of approximately 2% in March 2020.
In many countries, banks have been encouraged to loosen their lending criteria via government guarantee programs, helping to inject liquidity into the economy. The government of Italy, for example, has offered a EUR 500 bln guarantee program (including guarantees via SACE Simest – the Italian export credit agency) to banks, thereby de-risking lending activity to banks.
Moreover, the rejection rate by banks for loans to euro area enterprises continued to increase, according to the euro area bank lending survey, First quarter of 2020
It is interesting to note that in the Visegrád Four countries, lending has been much more subdued, although it is worth noting that the statistics are available only until March; perhaps April will show more of an increase. It is also possible that the depreciation of Central European currencies is a reason there was little if any growth in euro-denominated amounts for the region.
From our exposure to debt markets, we see a number of motivations for new indebtedness. First, there are the “losers” from the coronavirus, such as the tourism and automotive industries, which have seen a dramatic decline in revenues, face ongoing future uncertainty, and need to create cash or credit reserves to weather the storm.
Second, there are also a few “winners” from the coronavirus, such as certain online retailers, pharmaceutical companies, etc., which need capital to fund expansion.
A third motivation is simply to lock into interest rates that are incredibly cheap by historic standards.
The “take home” message for any owner of a company reading this article is that now is a good time to raise debt. Interest rates are low, and liquidity helps reduce risk in these highly uncertain times, and allows companies to take advantage of opportunities in this coronavirus environment, especially if the coronavirus triggers a prolonged recession.
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.