The first quarter of 2020 will go down as one that many in the global capital markets will take quite some time to recover from. The scale and severity of the Covid-19 pandemic in the region delivered a brutal shock to the financial system from early March, triggering widespread volatility. The impact on the bond markets, while immediately generating huge trading volumes, quickly bifurcated into record issuance in investment grade and a shuddering halt in high yield.
Europe saw €148bn worth of bond issuance over the quarter, down from €202bn in Q1 2019. But this disguises the extraordinary activity in March and April as corporates and financials scrambled to shore up their finances in the face of widespread lockdowns and the complete cessation of business activity in many parts of their economies. Between 1 March and mid-April, €110bn was issued in Europe, a 131% year-on-year increase, and in the first week of April 2020 alone, European IG bond issuance hit an all-time weekly record of €56bn.
Indeed, the first quarter of 2020 saw bond issuance globally surge to all-time highs, with $2.7 trillion of deals sold worldwide, up 5% on 2019 year-on-year. Indeed, on 30 March six large deals were sold on one day, including Oracle’s six-tranche $20bn issue, 2.4bn from British American Tobacco and €2.2bn from Volkswagen. Activity was very unevenly distributed, however, with US issuance up 34%, but bond sales in Asia Pacific down by 17% and in EMEA down by 8%. In Japan, issuance was up by 17%.
The surge in bond deals was almost exclusively from investment grade issuers, looking to increase their working capital and build up buffers in the face of unprecedented economic uncertainty. According to Dealogic, 86% of investment grade bond issuance between the beginning of March and mid-April was intended for general purposes with just 2% for acquisitions and 12% for refinancing. In Europe, consumer goods company Unilever launched and sold such a €2bn bond deal on Friday 20 March, just as most offices and trading rooms across London were emptying and everyone began working from home.
The robust issuance levels are a reflection of the extraordinary quantum of fiscal stimulus that central banks, clearly having learned the lessons of 2008, immediately pumped into the system. In the first three weeks of April alone the ECB bought €90bn of bonds through its temporary €750bn Pandemic Emergency Purchase Programme (PEPP). This has served to reassure markets that there is a creditor of last resort.
But even with the Fed and the ECB extending their programmes to sub-investment grade asset classes, the sheer scale of the economic shutdown quickly translated to a cratering of volumes in consumer asset classes. Despite the speedy introduction of payment moratoria in many jurisdictions, the volume of securitised issuance in Europe fell in the first quarter by 6% to €28.9bn according to the AFME. However, it was a full 42% lower than first quarter issuance in 2018. Despite this, UK RMBS still managed to rise from €6.6bn in Q4 2019 to €7.3bn.
Nevertheless, securitised issuance completely shut down across Europe for six weeks once the extent of the pandemic in the region became apparent – the last fully placed deal was for a Dutch specialist RMBS originator on 6 March. Signs of life emerged at the end of April when Permira Debt Managers and Redding Ridge Asset Management came to the market with CLO deals along with KKR, while Guggenheim Partners launched a €281.65m CLO at the beginning of May.
It is no surprise that it is CLOs leading the action, given that they will be in the eye of the storm in the wave of insolvency which will follow the withdrawal of the temporary government support schemes that have been introduced. Many banks and asset managers are anxious to clear the loan warehouses that they have been building up, and are using CLOs to do this. Rating agency Fitch now sees the default rate on European leveraged loans increasing from 3.4% in December 2019 to 5%. According to the AFME, leveraged loan issuance totalled €4.5bn between March and mid-April 2020 – down 86% year-on-year. The story was the same in the European high yield bond market where a total of €701m was issued in this period, a 93% drop from 2019.
It is difficult to see how quickly many ABS asset classes can recover in the short term. The massive ramping up of ECB and Bank of England monetary easing provides many originators of consumer assets with a cheap and plentiful funding source for the foreseeable future. The steady supply in the market over the last six months also means that many large issuers are already fully funded. Within the capital market sector, this is considered a solvency crisis, not a liquidity crisis, and the focus is, therefore, likely to be on CLO performance, where the underlying collateral will be hit by rising defaults, putting the equity and lower-rated debt tranches at growing risk as well.