Huge liquidity risk faced by corporates is implying new behaviors and reactions
AB-INBEV Syndrome and Carnival's compromised
This crisis will have already demonstrated, but we are far from our last surprises I guess, that the reactions from companies could be diverse and that “the end justified the means”, according to the popular saying or in French "à la guerre comme à la guerre".
The cases of AB-INBEV and Carnival Cruises seem interesting to me in more ways than one. The first is that the borrower has made full use of its established lines of committed credit facilities in place (and we guess the uncommitted too) for fear of a drying up of liquidities on the market (i.e. credit crunch situation) as if their banks might not be able to meet their commitments towards the borrower. The situation is very different from 2008, isn't it? It was a bank crisis when today it is a financial crisis following a pandemic. Banks aren’t culprit anymore. They are potential part of the solution for the real economy to survive. A completely different story.
The second case is a case of "compromise" as I call it where the company to obtain vital credits and extensions of credit lines for its (momentary) survival (and hopefully medium term survival) has granted guarantees and pledged its essential assets, i.e. its fleet of cruise ships (estimated value $28 billion as well as some intellectual properties in addition). They gave basically everything that has a value. It's a first case of what could be renewed by other corporations in destress. This is what happens when you are under extreme financial and liquidity pressure. They received $4 billion (via bond issue) against the guarantee of their fleet of cruise ships valued at much more of the nominal value of the security issued. They have created a kind of precedent or “school case” that others will be able to follow in view of the current exceptional situation. We're talking about a coupon of 11.5% anyway... for a three-year loan. The return is excellent, although the risk is high. Since they still had an investment grade rating before the crisis, they could "pledge" their assets freely whereas before they borrowed on an unsecured basis (i.e. without guarantees or pledges). The new bond holders will be preferred with a higher rank compared to those of the $16 billion of existing pre-crisis debts, in the event of bankruptcy. A new taboo has been broken and is shattering. Many companies will want or will have to adopt the "do a Carnival" method.
These two scenarios are examples of what is likely to happen: a rush on the lines of credit in place (if enough and if not cancelled by bankers for the uncommitted ones). The "let's draw down all outstanding headroom on lines of credit, you never know" approach could emulate and give ideas to others... This is not ideal and extremely expensive because you pay the "utilization fees", the borrower spread and finally the negative interest when replacing the surplus cash. The bill will be expensive. Financially, that is not what you should teach in Universities and Masters. The second case will leave traces beyond the previous one. Holders of less secured "bonds", less protected and without pledges will be scalded. We believe that they will not come back to reinvest their funds in such companies. Crises often leave scars and bitterness. It's like “shooting in your foot” and making sure you will face funding difficulties for the next 10 years. Will that be enough? We hope for them… Is it the ultimate attempt to save itself? Survival is priceless, I can suspect. We'll see... But this is one of the many lessons of this crisis. Things will never be the way they used to be, and capital markets and loan markets will be transformed in coming years. We will see new provisions and clauses to better protect lenders and investors and to give them exit doors, when possible. In finance, major changes are initiated after crises. The COVID-19 ‘s one won’t be different.
Are bankers the new Doctor of Economy?
The CEO of SocGen made an interesting comparison and said compared banks to the “doctors of the economy”. However, after the GFC, it seems normal to put pressure on unloved bankers to do the job and bail out the trouble “real economy” corporations. Today, the crisis is primarily a health crisis, but according to IMF, the size of it has led to an economic crisis, and it could turn into a financial crisis at the end of the day. I fear it could be a capital market crisis too. The EU CMU project intends to better balance bank lending and capital market operations. However, we must hope the capital markets will resist. The amplitude and the cascading effect on the real economy. Risks have grown and the regulations of the non-banking financial system and “shadow banking” should likely be revisited (after the COVID), because it could amplify the problems and become a full-blown financial crisis. I won’t be surprised to hear about more and more defaults or companies missing payments related to loans or bonds. The financial markets really need, it is time now, good news from the containment front.
Fran?ois Masquelier - SimplyTREASURY