Nordea's Johan Trocmé talked to Philip Asp, Head of Investment Banking at Nordea, about what could happen if containment efforts to halt the spread of COVID-19 lead to sustained major disruptions in global supply chains. Corporates need to consider the potential impact on liquidity, funding and even recapitalisation needs, as well as potential hostile bids under stretched circumstances.
JT: Containment efforts to limit the spread of COVID-19, such as quarantines, are disrupting global supply chains, and corporates are starting to feel effects from supply shortages and lost revenue. If this were to drag on for an extended period, affected corporates’ cash flow and liquidity would suffer. How do you think a tough scenario could play out in credit markets? Availability of bond and commercial paper funding? Usage of backup RCFs? What type of borrower would face the greatest challenges?
PA: The majority of corporate bond issuers in the Nordic region have access to several alternative sources of liquidity that can be tapped in case of a sustained closure of the local and international bond markets. For many Nordic blue chips, the revolving credit lines are intended to remain undrawn and are usually used to back up commercial paper issuance and other capital market debt. It is therefore more likely that corporates would explore alternative liquidity sources ahead of such drawings, such as establishing bridges to bonds, bilateral loans, convertible bonds or even equity issuance.
We do not, however, envisage a prolonged primary debt-market freeze. It will be paramount for the ECB to secure the functionality of especially the EUR investment grade bond market, given that it has greatly increased in importance for corporates as a funding vehicle over the past five years. And the ECB is itself a big investor in this market.
From an all-in yield perspective, corporates have a very benign pre-crisis starting point, with the ten-year EUR swap rate now only 10 bp from the August 2019 low. This means recent credit spread widening is mitigated, albeit not fully neutralised.
The most affected sectors have been transportation (freight and airlines), energy-related, and consumer-driven sectors such as brewers. And, as always when the market is in ’risk-off’ mode, high-beta issuers with aggressive capital structures underperform the overall market.
The most affected sectors have been transportation (freight and airlines), energy-related, and consumer-driven sectors such as brewers.
Philip Asp, Head of Investment Banking at Nordea
JT: In a prolonged disruption scenario, what could typically trigger a need to raise new capital? Liquidity reserves? Cash flow trends? Rating downgrades? Collapsing absolute equity values from falling share prices? Debt covenant breaches? Which are key for corporates to watch and protect? Can they prepare in advance?
PA: Yes, several factors can act in tandem to trigger a need to raise capital during a sustained period of market weakness.
In the current environment, proactive liquidity planning deserves to be at the very top of the financial agenda for the corporate sector. The initial impact of the current global supply chain shock will likely be felt in corporate earnings and, related to this, result in profit warnings owing to weaker cash flow generation and projections.
This, in turn, implies an accelerated depletion of available liquidity for corporates, concurrently with weakening credit metrics, as EBITDA wanes and debt obligations remain unchanged. And this is a treacherous path that could prompt rating downgrades and result in breached debt covenants. In either of these scenarios, successful capital raising can be used to shore up liquidity, bolster the balance sheet and stabilise the ratings.
In any such challenging scenario, being well prepared with the available ’tool box’ is the obligation of the CFO and Treasurer – to have the option to act while alternatives are still available.
In the Nordic region, we could see a fresh wave of issuance of hybrid capital (both IFRS equity and rating-protecting ones), as we have seen historically.
Preservation of liquidity buffers, compliance with debt covenants and protection of investment grade ratings will be key focus areas.
In any such challenging scenario, being well prepared with the available ’tool box’ is the obligation of the CFO and Treasurer - to have the option to act while alternatives are still available.
Philip Asp, Head of Investment Banking at Nordea
JT: How should corporates think about risks of hostile bids in a potential challenging capital markets environment? If a well-managed business sees a depressed share price on supply chain issues and a ‘risk-off sentiment’, could it face an opportunistic bid from a well-capitalised entity? What can be done to prepare or to defend if the situation arises?
PA: Indeed, there could be an opportunistic bid on the back of falling valuations and weak Scandinavian currencies. On the other hand, financing for a bidder might also be more challenging, especially if a higher leverage structure is envisioned.
Furthermore, the target company’s shareholders would normally view the value of the target based on longer-term factors, not on potentially temporary dips due to extraneous factors.
In addition to maintaining a general readiness to respond to any approaches (appointing a takeover defence adviser, where relevant), preparations should be made to try to mitigate business and financing disruptions to the largest extent possible.
You can read a summary of Nordea on Your Mind’s ‘Coronavirus and supply chains’ report here.
For more information, please write to Richard Hayes or speak to your Trade and Working Capital Sales contact to discuss how Nordea can work with you and your supply chain.
The information provided within this website is intended for background information only. The views and other information provided herein are the current views of Nordea Bank Abp as of the date of publication and are subject to change without notice. The information provided within this website is not an exhaustive description of the described product or the risks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient.
The information provided within this website is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sale of any financial instrument. The information provided within this website has no regard to the specific investment objectives, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is not indicative of future results.
Nordea Bank Abp is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction.
The information provided within this website may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Bank Abp.