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Largest worldwide crash test ever launched is under progress… Fasten seat belts!

12 years after GFC, we start again…

Remember, when about 12 years ago, banks were bailed-out at cost of billion of EUR during last GFC, it was supposed (at least it is what I understood) to be a one-off intervention by States and Central Banks, dedicated at saving the world economy and prevent the biggest collapse ever. But just a dozen of years later, we are facing another “black swan”. To be clear, I prefer to talk about a “green swan” that turned into a financial crisis worldwide. Again and again, giga – mega bail-outs are announced every day, with billion value measures. What is different this time? The banks aren’t the root of the problems (for once). However, there are a major actor of this play and could be hit too indirectly. This idea this time is to protect the “real economy” and to stop them running out of money because of businesses stopped brutally.

Prospect of mass default

Mass default could be avoided although this crisis will hurt significantly. But a category will be strongly punished: the “junks”. These companies relying on non-investment grades (the so-called “junks”) aren’t part of bail-out plans. Lots of these companies have unbalanced capital structure where they rely on high volumes of short-term debts when their liabilities are more long term. There are duration mismatches which could kill them when short-term markets froze or close. We can give a perfect example with “WeWork”. The level of debt has increased in the world and the scale of default risk has ballooned too.The mounting risks with such low-rated borrowers could be destructive for the whole system ( counts for a quarter of total debt issued last year). Default rate could reach 10% this year according to S&P. Scarring isn’t it? Could we stomach that, or should we save some of them via nationalizations? Who knows…

High cost for additional debt

Another interesting example I like is CARNIVAL, rescued by huge financing. Carnival cruise holiday company has been refinanced by USD 6 billion during the pandemic. It reassures and proves funds could be found, providing we accept to pay the price for them (mainly high-yield senior debt – five years).

They will have a coupon at 11,5% !!! The ships are the potential collateral for 40 billion maybe. In total they have circa 12 billion debt for 5,5 billion EBITDA. Additional debt can have a huge cost which can make the service of debt difficult and highly depending of the business, which must be back on tracks as soon as possible to rebalance the situation. I wonder who wants to go on a cruise these days? Good luck guys! The risk is to pile up debts, to increase cost of funding and to be over-dependent on market turmoil and recovery.

Some markets should be rescued

The ECB has planned to launch a EUR 750 billion plan for purchasing short-term papers. It will be an oxygen balloon for investors and issuers. Let’s take the example of the NEU CP commercial paper market in France, which is important for the country and its economy. This market was quasi closed mid-March. Like in 2001 and 2008, investors are leaving this market in order to increase their liquidities. The risks are the absence of culture for short-term paper at ECB and the strict conditions with minimum ratings. It should be allowed to invest in low rated debt of corporates, as it did with Greek debt for example in 2011. MNC’s have been encouraged by regulators since last GFC and recently with project like Capital Market Union (CMU) to rebalance their debt towards capital markets. But if these markets are supported by Governments, ECB and central banks, we will have problems. Acts should follow talks… if not it won’t work. Beside this specific market, all Money Market Fund managers will be penalized too. It is not good news for the liquidity of the whole market. ECB should adapt its policy and behavior to exceptional circumstances to save the financial world.

Deluge of downgrading could be foreseen

Do you remember that many analysts considered during last GFC that the rating agencies were the culprit? In reality, lots of financiers have forgotten that agencies issue “opinions” and that is not an exact science as mathematics or physics. We saw number of cases where they made mistakes in assessing risks. The challenge for these agencies is to determine how to adjust to COVID-19 pandemic, slashing assessments of vulnerable corporations under scrutiny of critics who say their hasty downgrades in the last GFC caused undue stress in financial markets. In March we faced the fastest pace of downgrading, close to 2002 record year. Here we are with a “déjà vu” all over again. They claim that they try to react to changed circumstances reflecting sudden strains that have emerged as a result of the Corona virus outbreak. I am convinced that the issuer-paying model will soon again be questioned. If crashes and collapses arise be sure they will be considered as culprit. Their job is not to move all ratings down, which wouldn’t serve anybody. However, it may happen e.g. FORD and M&S have been downgraded from the lowest level of investment grade to sub-investment grade. That the major dam. When you pass into the dark side, the risks and costs increase a lot. This crisis demonstrates that business models are changing and that companies need to adapt to survive. Some “old models” still exist and I am afraid this biggest crisis ever could kill slow movers, force other to accelerate digitization and transformation and at the end of the day, the world will not be the same anymore. We will enter a new dimension and people will change their consumption habits and ways of living which will be also dramatic for some of the old economies. A crisis is always an opportunity to clean a situation and to reorganize the whole system. Nevertheless, it has a price and it will be expensive, I guess.

François Masquelier - ATEL


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