COVID-19

The European high yield market has shown remarkable resilience in the face of what will likely go down as one of the sharpest and most severe recessions in history. The benchmark iTraxx Xover index (a widely used proxy for Euro HY credit risk) has tightened from an intraday high of 730bp in March to 342bp earlier this week, a retracement of almost 75% from the January lows of approximately 200bp.

In the past few weeks CLOs have become the focus of much attention, both from market participants and the media, especially following the negative rating actions that agencies have taken on the underlying loans as well as CLO tranches.

A few weeks ago Bank of America Merrill Lynch’s CEO, Brian Moynihan, said that loan losses were not coming through as thick or as fast as he would normally expect for a recession, in particular a recession of this magnitude.

Markets opened today to the news that German Chancellor, Angela Merkel, and French President, Emmanuel Macron, had reached an agreement to support the launch of a €500bn support package to aid the European Union’s recovery from the coronavirus outbreak, which has devastated large parts of the continent.

After six weeks of no supply, the market somewhat surprisingly reopened with three new issue CLOs being priced last week and a new one already on the way. We are aware of many loan warehouses that need to be cleared, and bankers (or rather their risk managers) are no doubt keen for CLO managers to refinance leveraged loans into a CLO.

Over the past couple of months risk markets have experienced unprecedented volatility, and the economic uncertainty caused by the COVID-19 pandemic looks set to continue while a proven vaccine or an effective treatment both remain elusive.

The European high yield sector has seen a sharp correction from its highs earlier this year, with the Crossover index moving from a tight of 203bp in January to an intraday wide of 730p on March 18 (by this morning it had also seen a retracement of around 50% to 470bp).

After a considerable period of zero activity new issue bond markets have reopened this week with a flurry of deals in the US and now in Europe. As usual it has been frequent high quality borrowers reopening the marketplace, and they have done so with confidence from their syndicate bankers that attractive pricing will result in successful transactions.

Yesterday we blogged on how European HY had always led recoveries in UK equities this century, and that even more so this time around we expect the same to happen.

With markets in turmoil and economies around the world shutting down to slow the spread of COVID-19, many investors have been looking to the US to lead the stimulus effort on both the monetary and fiscal policy front. This week they may have got it.

In the last two weeks we have seen savage falls in risk assets, but with the unprecedented stimulus and support action taken by policymakers globally, many investors’ minds have inevitably turned to when risk assets might be a buy again. More specifically, given equities are higher beta assets in multi-asset portfolios, when should asset allocators be buying equities again?

In the case of Aareal Bank the management decision is understandable in our view; should the market panic and begin to offer extended AT1 bonds at a heavy discount, then investors could see this as a real opportunity over the medium term.