Furthermore, the majority of regulated utilities and non-GDP linked assets have seen week-on-week pricing improvements as their resilience to the macro market is reinforced. This is important to highlight, as once EUR iBoxx is back below 200 basis points, issuance will start to look attractive again, especially with compressed underlying rates. Another clear market indicator is the High Yield Bond market re-opening this week, albeit at nosebleed pricing. We understand that a number of issuers are preparing to access the bank and PP markets if conditions allow in the coming weeks.
‘Sell in May and go away’ is a long-standing mantra in the publicly traded equity and debt markets. The view has always been that an investor would sell their position pre-summer holidays and revisit their positions after the summer once assessing how the markets have performed, before potentially buying back up again. Many commentators have described this phenomenon as the basis for many market wobbles and crashes – the notorious stock market crashes during 1929, 1987, 2008 all happened after the summer. Interestingly, as this was not a market-built phenomenon, and it’s highly likely that travel restrictions will remain intact, there could be a sentiment of ‘back to your desk in May and get that capital away’, as lenders start to deploy capital and borrowers start issuing in the infrastructure market. Only time will tell if issuers have the confidence to test this market, sooner rather than later.
We are, however, not out of the woods just yet, and while we’ve seen a high number of credit downgrades, there may be more on the horizon. Moody’s is estimating the global default rate for sub-investment grade debt to almost triple, from c.4% currently to c.11% by early 2021, or potentially quadruple to 16% under its pessimistic view. Infrastructure assets however, true to their name, have been relatively protected, with rating movements continuing to be tempered by the significant government support measures taken across Europe and the US to date, combined with financial flexibility and stronger liquidity for the investment-grade issuers. That being said, there are a number of volume risk transportation assets which agencies have flagged for downgrade watch, with most issues cited centring around covenant breach risk and liquidity.
Furthermore, with challenges rising for certain asset classes who are at risk of downgrades, capital costs for lenders are increasing, culminating in higher loan loss provisions. With higher provisions, and mandates to only hold debt of a certain credit, lenders are being forced to sell down positions to meet internal requirements. This is leading to yield opportunities for debt investors in relatively robust assets, but could also stimulate interest from distressed investors looking to extract value from weaker borrowers. Distressed loan investors could then frustrate potential work-out, or covenant waiver processes to improve their position in the capital structure and extract additional value. Issuers can defend against these strategies by having strong documentational protections, including transfer restrictions, however, there are often ways for lenders to get around such protections. It is key to understand the current make-up of the lending syndicate, including voting thresholds, and to give added consideration to potential breaches, including financial covenants, or general events of defaults (including MAC or cross-default provisions).
In summary, while the broader infrastructure market is seeing improved appetite for lending, and may pick up actively in a meaningful way soon enough, there are some infrastructure sub-sectors that will need to do some heavy lifting to see this through, with the reaction of rating agencies and the lender base not as certain.
DC Advisory is always on hand to support and help sponsors and borrowers in understanding these market dynamics and structuring considerations, and would be delighted to get in touch should you have any questions.
