Many financial markets collapsed last week as fears about the spread of the coronavirus, Covid-19, grew rapidly, with leveraged finance not going unscathed. There are, though, tentative signs of stability emerging in the loan and high-yield markets, as technicals look set to once again trump fundamentals.
Looking back at last week: equity markets cratered, the cost of default protection soared, high-yield indices recorded the largest daily losses in three years, and even the typically unflappable loan market posted some of the largest downward moves in the European Leveraged Loan Index (ELLI) in more than a year. Meanwhile, U.S. leveraged finance markets fell even further than their European counterparts.
Equity markets led the way, with the Eurostoxx 50 down roughly 10% last week, the FTSE 100 off 10%, and the S&P 500 down 6.5%.
Against this backdrop, the cost of default protection, as measured by the iTraxx Crossover, climbed to 308 on March 2, compared to 212 on Feb. 14, taking it back to levels last seen in June 2019. Note though, it tightened to 287 on March 3.
The impact in the leveraged finance arena was felt most heavily across high-yield, with some market participants citing that Monday, Feb. 24 saw the biggest daily fall in benchmark indices in three years — although this only took spreads back to January levels. Since then the sell-off grew more savage, and traders report selling interest outweighed buying by as much as 10:1 on some days last week. That said, selling pressure until late in the week was orderly, and although the wider market was under pressure, market participants still felt it was fairly resilient — until Thursday and Friday morning that is, when the downward pressure grew.
The weakness is evident in LCD’s European bond flow reading, which fell 314 bps on Feb. 27, to 99.75, compared to 102.9 last week. This compares to the 103.4 reading taken as recently as Jan. 16, which was the highest since November 2017.
Some firms have felt the impact more heavily than others, depending on the proximity of their operations to areas where there have been higher numbers of reported coronavirus cases. CMA CGM, for example, lost 792 bps over the last seven days (as of Feb. 27), falling to 67.67 on the bid. March 3, though, saw the bonds rally 300 bps.
Indeed, Tuesday saw a rebound, and market participants will be hoping the bounce is not of the dead cat variety, and there are reasons to think it won’t be. This is because, with the Fed surprisingly cutting rates by 50 bps— as well as hopes rising of more stimulus from the ECB — the technical backdrop has been bolstered further, in the hope of offsetting the impeding decline in fundamentals. And as the market has been aware for months now, technicals tend to trump fundamentals.
“I know of at least one manager that received sizeable inflows today,” comments a high-yield banker. “This isn’t really that surprising. Everyone expects more stimulus, and people just can’t buy govvies anymore. That means money will either flow into high-yield directly or trickle down.”
This dynamic could prove crucial, for should sizeable outflows emerge, as these tend to lag underperformance, then the wind would be taken from the sails of any recovery. But should they prove mild — or even better, inflows pick up — then fund managers will likely add risk as levels have become more attractive.
Loans not immune
The loan market has not been immune to the sell-off. Over the last seven days, through Feb. 27, the ELLI recorded its lowest return since the sell-off of late 2018, as the Index shed 35 bps. It has since lost 27 bps this week. As uncertainty mounts, volatility has increased. The standard deviation of daily returns (on a rolling seven-day basis) is six basis points, versus 1–2 bps throughout most of 2019.
As an asset class, loans are generally slower to react to outside events given the technicals here are underpinned by an active CLO base and other long-only funds. However, with equity markets a sea of red, loans have since followed, with the weighted average bid of the ELLI falling to 98.08 as of Feb. 27, from a high of 98.66 at the end of January 2020. This was a high not seen since November 2018, while the moves this week have wiped off all the gains made so far this year.
However, given that January volume in the loan primary market topped €19 billion (making it the busiest month since July 2007), there was some expectation among market participants that a slight correction was due, and prices have been slowly correcting for the last few weeks. There is no doubt though that the wider market sell-off due to coronavirus fears has accelerated the repricing in loans this week.
“We were done with where it had got to,” said one investor. “There was such a rapid repricing in a short space of time — it was hard to see how that tightening would stop. There had to be a floor, and I think we’ve found it.”
The cautious sentiment has also been felt in loan primary, with repricings from AlixPartners, Messer Industries, and Minimax postponed last week, with the borrowers citing ‘adverse market conditions’. Moreover, new issues in market this week are widening pricing to add comfort for the backdrop, but the fortune of each deal will be credit-dependent. Gerflor, for example, added 25 bps to the margin guidance but also accelerated pricing to this Friday, indicating more than strong enough demand, while banks are sufficiently constructive to launch a new debt raise for Bio-Group. All eyes though are on Polynt-Reichhold as it has some Italian and Chinese exposure, and is due to price today.
Over in high-yield, Jaguar (which has exposure to China) postponed a planned bond issue in the U.S. the week before last due to the impact of the coronavirus, while in Europe Fugro last week postponed its debut €500 million offering as market conditions soured aggressively.
How loan and bond primary markets fare in the next few weeks remains to be seen, but until secondary prices stabilize, it is hard to imagine new deals will launch.
“Right now we would probably wait a bit before launching,” said a head of leveraged finance. “There aren’t a lot of underwrites to come through, though there is a bit, with BASF, Cerelia, PureGym, and Stonegate springing to mind. I suspect a good credit that isn’t priced to the screws might get done in this market, but we will take it day by day.”