Financing markets nearly shut down when the pandemic hit, but in contrast to the experience following the onset of the 2008 financial crisis, they didn’t stay that way for long. This Wachtell memo reviews the acquisition finance market during 2020 and raises some issues that will be on the radar screen in 2021. Here’s the intro:
The Covid pandemic and fears of a global recession roiled financial markets around the world in March and April: U.S. investment grade risk premiums reached their highest levels since the Great Recession and investment grade bond and commercial paper markets briefly froze; the leveraged loan and high-yield bond markets seized shut; and the amount of U.S. distressed debt (bonds yielding at least 1,000 basis points more than treasuries and loans trading for less than 80 cents on the dollar) ballooned to nearly $1 trillion.
Unlike in the Great Recession, global financial markets quickly stabilized, and markets and banks proved to be a source of strength for large and mid-sized companies of all credit profiles. Companies moved quickly to stockpile liquidity (first by drawing existing lines of credit and then by exploring more creative options) and secure temporary covenant relief. Some companies, such as Expedia and Gap, fully reconfigured their capital structures, moving swiftly and nimbly to strengthen their balance sheets and ride out the storm. Government stimulus programs and central bank activity—including the Federal Reserve’s cut in interest rates to zero and intervention directly in credit markets by buying corporate debt and ETFs—buoyed markets and set the stage for this binge on new borrowings.
By December, the script had reversed: investment grade spreads neared record tight levels; CCC-rated bonds reached their lowest yields in more than five years; and the amount of U.S. distressed debt fell below pre-Covid levels to $184 billion. High-yield bond volumes reached their highest December level since 2006.
While 2020 ended on a positive note, the memo highlights a number of concerns that cloud the outlook for 2021. These concerns include whether companies have a liquidity cushion sufficient to handle a resurgent pandemic; the consequences of the expiration of temporary covenant relief provided by lenders starts; and when & how companies will address the enormous increase in corporate leverage.
The memo goes on to address some of 2020’s lessons, including the need to be ready to move quickly when financing windows open, the need for buyers & sellers to pay close attention to issues surrounding financing certainty, and the importance of strategies designed to thwart debt default activism. The memo also lays out a number of acquisition financing issues to monitor in 2021, including the risks of convertible debt, the implications of the imminent LIBOR transition and the growing role of ESG considerations in credit assessments.
– John Jenkins