Illustration: Joe Wilson
HOW COVID-19 WILL TRANSFORM THE
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On March 20, blue-chip Unilever sold €2 billion of bonds. It’s a deal that would typically pass without much comment, but this time was different. The company was bringing the first trade in Europe to be attempted with all its participants working from home.
The borrower did have maturities coming up but was not desperate for the money. Investors, having seen US corporate bonds swing back to life a day earlier, poured in, with demand of more than €10 billion.
After nearly two weeks of meltdown, when even commercial paper was on the ropes and revolving credit facilities seemed to be the only money to be had, at last there was a sign that deals could be done.
Fast forward to mid May and youthful Norwegian video conferencing company Pexip was celebrating its $200 million flotation on the Oslo Stock Exchange. In just 10 weeks markets had gone from being shut to all but a select handful of supranationals to being open to a growth story IPO, albeit one that ticked the most on-trend industry box imaginable: helping people collaborate when they can’t be in the office.
By most measures the weeks of coronavirus crisis since the pandemic took hold in Europe and North America have been an extraordinary period for capital markets. According to Dealogic data, global debt capital market volumes from April 1 to May 26 totalled $1.5 trillion. That’s more than 35% up from the same period in 2019. Within that data are much more striking moves.
Investment grade corporate issuance has more than tripled, in both euros and the US market. Sovereigns, supranationals and agencies (SSAs) in euros have seen the same jump. In the US, high yield has nearly doubled; in Europe, a market with much less depth, it has fallen to just a third of last year’s figure.
European equity capital markets have seen deals worth roughly $26 billion, more or less flat year on year. But the business has radically changed – IPOs have gone, replaced by follow-on offers, many of them to raise new money. In the US, volumes have practically doubled to $80 billion, as a vast slew of convertible bonds adds onto follow-on offers that have tripled in volume.
Practically everything is back. There have been high-yield bonds, emerging market trades, even asset-backed securities. There has been rescue equity, growth equity, monetization and big M&A.
Such has been the level of activity that some have questioned if capital markets are once again displaying a striking disconnect with the real economy, in which job losses are rising and societies are only just coming out of lockdown.
Viswas Raghavan, CEO of EMEA and global co-head of investment banking at JPMorgan, disagrees with that analysis.
“There is no disconnect between the real economy and markets,” he says. “The activity you have seen is driven by planning for difficult scenarios. Companies are raising capital to buttress them for the uncertainty and the slow growth to come.”
The progression of capital markets from total dislocation to mostly functional in the three months of March, April and May came in three phases. When markets shut in March, CFOs and treasurers had nowhere to look other than their bank lines.
“Everyone quickly assessed their balance sheets and liquidity positions to make sure they had adequate resources,” says Michael Carr, co-head of global M&A at Goldman Sachs. “Although, in times like this, no one really knows what adequate is.”
As markets opened, beginning with bond issues from SSAs, then blue-chip corporates and finally more high-yield names, the pertinent question has become what to do with that access.
Mo Assomull, global head of capital markets at Morgan Stanley, sums up the journey that clients have been on: “They have gone from ‘I have no access’, to: ‘I can issue something at wide levels’ – and now to: ‘Let me think about my optimal capital structure for the longer term, given what we know of the environment.’”
Now the questions start. Should a company accept equity dilution at low stock prices or can it hold off? How should ratings factor into its calculations? Should it consider an acquisition?
In short, markets are no longer just looking at survival, they are looking at strategy.
“Investors tell me that they will be there at the right price, but want to know what they are buying: survival or long-term growth,” says another capital markets head.
You have seen everything that eventually happened in the last crisis, but in a few days instead of months- DCM head
Much like the recorded message that tells you that a bank “is required to record this call” before you speak to remote-working staff, no discussion with a banker can begin without the preface that “this is very different to 2008”.
But while the causes of the crises have nothing in common, dislocation that freezes commercial-paper and term-funding markets looks pretty similar, whichever way it comes about.
What has been radically different this time has been what some call the ‘worry-reassurance cycle’, which has been drastically shortened. The crisis seemed to have only just begun when central banks were already buying commercial paper and high-yield bonds, and regulators were telling banks they could use their buffers.
“You have seen everything that eventually happened in the last crisis, but in a few days instead of months,” says one DCM head.
Just a few weeks ago, issuers were still thinking not much further than liquidity. It was an unfamiliar feeling.
“Liquidity has been so freely available for the last five years that some have not paid full attention to debt balances,” says Barry Donlon, who was promoted to EMEA head of DCM at UBS during lockdown and promptly had to add 60 virtual one-on-ones with his staff to his to-do list. “The ability to raise debt has been an assumption.”
And while borrowers were wary of tapping much beyond the shortest tenors as markets reopened – particularly obvious among some of the earliest SSA deals – that has already changed as bankers urge their clients to think through to the longer term.
“The key thing is to not get too focused on the recent past and to try to remember what investors wanted before the volatility,” says Lee Cumbes, head of public sector debt capital markets at Barclays. “We are now yet again in a world where there will be very low yields for a very long time. Investors will want long-dated product again.”
After SSAs, blue-chip corporates were quick to come – sometimes with deals dispensing with guidance and jumping from initial price thoughts to pricing to limit exposure in jittery markets.
Unilever’s deal is one regularly cited as a pivotal moment. The company did have reason to issue: some €2.4 billion of maturities in the period through August.
“The market needed a transaction like Unilever to reopen it,” says Mark Lynagh, co-head of EMEA debt markets at BNP Paribas. “They paid a decent premium for access, but it sent an important signal to other corporates that it was a good idea to come.”
It wasn’t the case that everything could fly off the shelf as pent-up demand was unlocked. Amid the flurry of deals, more challenging names struggled.
It was not even a matter of pricing, say bankers, but simple demand.
“If I am seeing $60 billion of supply in a week, why would I buy an esoteric name?” says one.
After all, investors had been able to pick and choose from among the best names in the market.
Just a few days after Unilever, Philips brought a tightly priced deal even though, with no maturities this year at all, it had no need for money. It joined the clutch of other early names that issued from a position of strength to better prepare themselves for the crisis and what may follow.
Some areas have been quieter than the same period last year, but with good reason.
Fred Zorzi, global head of primary markets at BNP Paribas, notes that European financial institutions (FIG) issuance was a laggard through much of the early period of markets reopening, even when their US, UK and Canadian cousins were tapping the markets.
“You fund for a few reasons – overall funding needs, your MREL [minimum required eligible liabilities] buffer that you need to fill and capital,” says Zorzi. “The consensus on the issuer side is that regulators could be flexible in terms of timing of capital and/or MREL requirements. Also, this has not been a FIG crisis, but spreads on FIG went very wide. And that was after the market had been open at the beginning of the year, when spreads were good and a lot of issuers had gone early.
“So overall, there was less urgency once the crisis hit.”
Euromoney speaks to Zorzi on the day his own bank came to market with a €1.25 billion senior non-preferred deal on April 16 that had been planned at €1 billion.
The book came in at about €5 billion at final pricing and looked fairly normal. In the early days of market reopening, SSA issuance in particular had been heavily supported by central banks and bank treasuries, with real money staying on the sidelines.
“If anything, we had more investors than usual,” says Zorzi.
Helping that deal and others around it was yet another crucial backstop from the Federal Reserve, which announced an expansion of its support measures on April 9.
“That addressed almost everything, from commercial paper to triple-A CLOs [collateralized loan obligations] and high yield ETFs [exchange-traded funds],” adds Zorzi. “We might be about to enter the biggest cycle of downgrades in the history of the bond market, but there will be support from central banks. There is not going to be a cliff.”
Soon after the initial rush for bank liquidity came the demand for equity. Investors are being deluged by requests. Some have been pushing back.
“We were very clear when this all kicked off that we were not going to be here as a cash register for everyone who wanted to raise equity quickly because they were worried about the future,” says an official at one of the biggest global equity investors.
“What we will need to understand before we part with cash is what else companies have done to address their financing needs.”
Equity, say investors, needs to come at the end of a process that starts with bank lending, debt issuance and corporate self-help measures like the cutting of dividends. That is the first requirement, the second is that companies have a strategy that goes beyond mere survival.
Balance-sheet resilience is important but to little purpose without a more traditional long-term investment case when there is fierce competition for investor cash. And if the main argument is survival, it needs to be survival for a year, not just until November.
“For us, it’s a question of looking much further out if you don’t have that strategic clarity,” adds the investor. “But ideally, we want them to be saying that they are not going to use this money just to help their balance sheet but to improve the business.”
For this buyer, travel technology group Amadeus was firmly in this camp, bringing one of the earliest and biggest deals when it raised €1.5 billion through a quick-fire placement of shares and convertible bonds on the night of April 2.
“They were very honest about it – they said they wanted to make sure that they were going to be fine well into next year because they didn’t know what was going to happen in terms of infrastructure,” says the investor. “They would survive but didn’t think that some competitors would, which would open up opportunities.”
Less appealing to this investor was The Restaurant Group, owner of the Wagamama and Frankie & Benny’s chains, bringing a quick-fire 19.9% capital increase in early April to tide it over until the end of lockdown in the UK. But others did buy: Columbia Threadneedle committed £11 million of the £57 million deal.
Some argue that the new environment of remote working and urgent need will combine to simplify processes.
“I would hope that this crisis will do away with a lot of the bullshit that goes on with deals,” says one practitioner. “If you are a bank, you spend a lot of time doing unnecessary stuff to satisfy your client, breaking down demand from every Tom, Dick and Harry. You just won’t have time to do that anymore. You will need to focus on the people that are going to be the most important to your deal.”
When you look at the where indices are trading, people are basically ignoring 2020, and the 2021 outlook is assuming consumption levels of 2019- Viswas Raghavan, JPMorgan
Things might get quicker. Some envisage the more widespread adoption of a US-style IPO process, with the typical marketing period halved to two weeks and with no initial investor education period.
“People realize that it takes a huge amount of management time and expense to do these things, and the more you can save in this environment the better,” says the same source.
If that sounds like a recipe for the erosion of equal treatment of investors, it is already happening.
Regulatory easing in Europe and the UK during the crisis has allowed companies to raise up to 20% of their market cap (up from 10%) without the need to offer pre-emption rights to existing investors. Retail investors will find it harder to keep up.
It shouldn’t be impossible to cater for them, however.
Investment platforms such as PrimaryBid are designed to serve exactly that purpose. Compass, a UK catering company, raised £1.8 billion through an accelerated deal on May 19 that included a retail tranche via PrimaryBid.
So far, primary placings have dominated the landscape. But the selling of stakes freshly deemed non-core has also featured. Sometimes deals have come from a position of strength; at other times to avoid falling into a position of weakness.
PNC Financial’s decision in mid May to sell its 22% stake in BlackRock through a $14 billion follow-on offering of shares and convertible preferreds is regularly cited as an example of the first type.
IPOs are beginning to emerge, particularly for companies that can not only survive the crisis but potentially benefit from it.
Pexip is one of these. After a few early physical meetings in London and New York in January, the deal went virtual. And although it got a boost as interest in video conferencing surged, the IPO had already been well underway when reports of the virus started to emerge.
The big test for European IPOs is set to be the flotation of coffee business JDE Peet’s – another business, like Pexip, that could be seen to benefit from the current environment, as it derives most of its business from home-consumed coffee.
At the time of writing, orders were building fast after the deal opened on May 26. As with Pexip, the float is being bolstered by cornerstone investors. The deal may end up sized at around €2 billion.
Mergers and acquisitions, being the most strategic of transactions, are inevitably taking longer to return. But already there have been notable moves, not least the proposed £31 billion merger of O2 and Virgin Media announced in early May.
“That deal really is a showpiece for today’s virtual era,” notes Raghavan at JPMorgan, which is adviser to Liberty Global, owner of Virgin Media. “The whole deal was done on the back of virtual communications.”
Projects of that size will remain rare for some time.
Carr at Goldman Sachs believes M&A markets will recover in three phases, beginning with smaller transactions that start the process of reopening but allow companies to remain careful about their financial conditions and avoid potential interlopers.
“The second phase is a ‘near-in’ environment,” adds Carr, “where companies engage in ‘clean-up’ phases by buying or selling familiar assets – joint ventures or share-for-share mergers when two companies know each other well, often in the same industrial verticals.”
The last phase will be similar to the environment in 2018 and 2019, where behaviour becomes more aggressive because the time is right and markets are hospitable.
“Right now, we hope that we are in the back end of phase one and aspirationally in the beginning of phase two,” says Carr.
Companies are already worried about defence but also about how offence might look while the crisis is still raging. Bankers report some clients calling with concerns about predators, while others are asking if the time would be considered appropriate to buy something.
“I’ve never seen that reaction before,” says a banker, adding that it is a reflection of the fact that the coronavirus crisis is a humanitarian one. “If this was purely a financial crisis, I’d say it would be a different story.”
Bankers and their clients are having to make big calls not on when the old environment will be restored but when there will be more certainty what the new one will look like. What once looked like a period that would have to be managed while it lasted is now looking more like a long transition period to a different world.
“At the moment there is really no ‘before Covid’ and ‘after Covid’ – there is ‘before Covid’ and ‘during Covid’,” says one senior banker.
Many markets are discounting 12 months of earnings, which tallies with many of the best hopes for a vaccine, if one can be found.
“When you look at the where indices are trading, people are basically ignoring 2020, and the 2021 outlook is assuming consumption levels of 2019,” notes Raghavan. “That’s partly because people are not only looking at earnings but also at the lack of alternatives. Where else can you generate alpha?”
Many bankers say something similar and point out that the volumes and activity seen since the start of the crisis are a big bet by capital markets that there will be a vaccine – and that it will not take three years but perhaps one.
But it could be longer. It could be never.
However, even in that situation, only the very pessimistic would rule out improvements in treatment that could at least have a big effect on recovery time and mortality.
Whether for individuals or corporates, looking through the crisis means evaluating how pernicious it will be. Bankers are trying to sound hopeful; they do not always manage it.
“Whether it’s for a vaccine or a tracing mechanism or a treatment, you have a tangible set of smart people who are running like hell to save mankind,” says one. “Hopefully, it’s a year to 18 months for something.
“Compare that with if there’s a dirty bomb someplace – that’s a 50-year problem. You can’t think about what life is like even five years from now. But you can think about what it’s like one year from now.”
Every company and its bankers are trying to do just that – and hoping for the best.
|Datasite offers glimpse of distressed M&A to come|
Traders are not the only ones to make money in good markets and bad. Those who service the relentless need for information as investors grapple with rapidly changing corporate financials or a surge in M&A activity are also set to be in more demand than ever.
Rusty Wiley, chief executive of Datasite, reckons his virtual data room business is set to see a flood of projects. Already the landscape is shifting in interesting ways.
His platform, which typically gets used on more than 10,000 M&A projects each year, saw decent activity in January and February, as he had been expecting. After all, the first half of 2020 had been touted by many as a good one for M&A, particularly in the US, as financing remained cheap and the second half of the year would be disrupted by presidential elections.
What now looks set to happen is for the second half to be busy with a very different profile of business. In polls of M&A professionals conducted in late April and early May by Datasite and Debtwire, 70% of EMEA and US respondents, and about 60% of those in Asia, expected more restructuring activity in the next 12 to 24 months.
The flow of all new projects flattened in March, says Wiley, before falling by double digits in April. But in May he saw a recovery, and he says the growth was across the world. And while new projects dipped as the crisis took hold, other data was more encouraging.
“One thing that stands out is that project closures did not go down,” he says. “We typically run at about 7% to 8% of projects being closed each month, and that has held steady through the crisis. The fact that people kept their projects open tells me that they think this will pass and they want to stay at the ‘ready’ stage.”
If the poll respondents reckoned that distressed activity would dominate in the near to medium-term future, that is already playing out on Datasite’s platform. Distressed projects of all kinds – including debt restructurings, bankruptcies and private investments in public equity deals – went from 7% of Datasite’s total in January to 17% in April.
“Bankruptcy projects have already been scaling up in the last three weeks – people are ramping those rapidly,” says Wiley. “The only thing holding that back from being even more is the trillions of dollars of government support that is delaying things a bit.”
What has also changed is that people are having to rethink how much information they need to provide in their data rooms to take account of the new mass of questions and analysis resulting from the crisis. The ‘build period’ – the time before clients open up their Datasite data room to outside parties – is up by 54% since the start of the crisis, Wiley says.
Datasite already hosts about 276 million pages of data on its platform, with individual projects ranging from less than 1,000 pages to over five million for the biggest.
Historically the most data-heavy projects have often been for portfolios of non-performing loans. As government schemes roll off, there will be plenty more of those.