eResearch | The Covid-19 virus has created an environment of distressed companies who are scrounging for cash and capital infusions. As the corporate debt market tightened, the U.S. Federal Reserve was forced to implement a quantitative easing program last month to relieve the balance sheets of financial intuitions who were reaching capital reserve limits.
As the need for capital rises due to shelter-in-place government orders that have shut down economies, distressed debt funds aim to profit from the companies requiring capital to survive. Oaktree Capital (NYSE: OAK-A), who was a buyer of corporate debt during the selloff in March, announced plans to raise US$15 billion to create the world’s largest distressed-debt fund.
This week, Oaktree, alongside T Rowe Price and Blackrock, announced a US$1 billion debt financing deal with the peer-to-peer room rental company Airbnb, who only just a week ago raised another US$1 billion in debt & equity to strengthen its balance sheet.
As the debt capital markets regain confidence, investment-grade corporations such as Sanofi (EPA: SAN), Nestle (SWX: NESN), Diageo (LON: DGE), and Bank of America (NYSE: BAC) have issued bonds and notes.
Corporate Debt
Debt is a core part of corporate operations in business today, mainly due to the low interest rate environment of the past decade, which made it common for companies to constantly leverage debt to expedite growth, and then restructure the debt once maturity hit.
As economies shutter down due to the coronavirus, most industries are experiencing a cash crunch as debt obligations reach maturity and corporations who are in non-essential businesses, such as hospitality and entertainment, experience a drop in credit ratings with corporate bond prices declining in value.
Tui AG, a German travel agency, recently had its credit rating downgraded to BB- (junk) from BB by S&P Global Ratings, resulting in US$327 of its notes due October 2021 experiencing a 7% decrease in price.
Credit and Bond Market
The credit market has become volatile since the U.S. Federal Reserve took emergency measures earlier this month by reducing short-term interest rates by 50 basis points and bringing the U.S. 10-year treasury yield below 0.7% for the first time in history.
Even though interest rates are almost zero, the corporate bond market, which normally functions inversely with short-term interest rates, fell in value as the risk of insolvency for corporations increased due to deteriorating economies.
In early March, Virgin Australia Holdings, an airline subsidiary of Virgin Group, reported a sharp price drop in US$425 million of bonds due in 2024, due to the Covid-19 virus reducing expected earnings by 40% to US$47 million in 2H/2020. Yesterday, the company requested an immediate trading suspension of shares and unsecured notes until it can arrange financial assistance and seek restructuring alternatives.
AMC Entertainment Holdings Inc. (NYSE:AMC), an entertainment company with theaters shut down worldwide, had its US$600 million notes drop in price to 81 cents on the dollar to yield more than 10%.
Distressed companies are under pressure as the corporate bond market deteriorates and sources of capital are limited. As both governments and private funds start to support liquidity in the debt capital markets, it will be interesting to see which companies have long-term sustainable businesses capable to take on debt and pay back the interest and principal obligations.
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