After the storm
After enduring a turbulent financial year, many loan sector investors are already looking beyond the Covid-19 pandemic to future opportunity amid growing signs of market recovery. Here Alcentra acting co-chief investment officer of liquid credit Chris Barris and acting co-chief investment officer of liquid credit Graham Rainbow survey the lending landscape.
When the seriousness of the Covid-19 pandemic first became apparent in March last year, few assets escaped the market turmoil that ensued. And while the impact of the virus was not limited to specific geographies or sectors and of global scale it was notable in triggering the first real downturn experienced within the direct lending sector in Europe.
In the investor surge to offload assets, European loans briefly experienced some of their worst performance since the global financial crisis. Yet, paradoxically, this provided some rare opportunities for buyers to acquire stressed and distressed debt in the secondary market at yields not seen for many years. This allowed some investors, with an eye on the longer term, to gain exposure to potentially valuable assets at comparatively low cost.
Against this backdrop, Alcentra’s acting co-CIO of liquid credit Graham Rainbow says European loans have since show real signs of recovery from their 2020 trough. While the economic impact of lockdown measures weighed heavily on European corporate fundamentals during 2020, reducing earnings and cash flow and increasing leverage, some help was at hand. Government measures including wage-supporting furlough schemes, business rates and tax deferrals helped mitigate some of the downward pressure on corporate earnings and helped stave off at least some defaults.
Recent signs of market recovery have been driven partly by improving sentiment amid positive vaccine headlines which have raised hope of an imminent end to the pandemic, though Rainbow adds that the presence of virus-related market risks persists.
Elsewhere, in the US loans sector Alcentra acting chief investment officer of liquid credit Chris Barris says sector technicals have so far benefited this year from a steepening yield curve, with 10 year yields at their highest level since last March.
“US Loans in particular have benefited from a sharp upward shift in the yield curve accompanied by the steepest ‘2-10’ since 2017, which has led to strong retail inflows, a contrast to what the market has seen over the past two years. Loans also appear to have performed well in recent months, outperforming more duration-sensitive corners of the fixed income market,” he adds.
Despite these positive signs, Barris points out the opportunity for yield across traditional global fixed income markets remains challenging – with roughly US$18trn debt outstanding and trading at negative yields. While he adds defaults within the loans sector appear to have peaked, considerable uncertainty lies ahead.
Despite these challenges Barris believes the loans sector does hold opportunities. In particular he says areas of the market more heavily impacted by Covid-19 – including those in the CCC space – should recover from the worst of the pandemic over time and could hold significant potential.
At a wider market level, Barris does however anticipate more pockets of market volatility and dislocations in the year ahead and remains cautious on the overall outlook.
“Upside could come from a stronger-than-expected economic rebound that improves the default and recovery outlook and raises prospects for higher short term rates. On the other hand, downside risk could stem from weaker-than-expected economic growth and a return of rating agency downgrades and ultimately higher defaults,” he adds.
Either way, both the European and US loans market have demonstrated resilience in the past 12 months – though Barris adds the market influence of the pandemic will still likely be felt for some time to come.
“The impact of Covid-19 has been far reaching, especially across developed markets. The swift responses by global central banks and governments was critical in stemming the adverse impact on financial assets, providing an implicit and, in some cases, explicit support.
“Nonetheless, the impact on economies and our previous way-of-life has been extraordinary, upending small businesses and families and is likely to have longer term implications for both everyday life and financial sectors such as the loan markets,” he concludes.