More than 90% of companies have now reported second-quarter results and updated the investment community on their plans to tackle the unique economic headwind coming from the dual shock of the oil-price crash and the coronavirus pandemic. The environment is fluid: ratings downgrades are at multi-year highs, and we have little sense of the full impact of the current drawdown.
This uncertainty is reflected in the dispersion between the spreads of different credit ratings (see figure 1). Compared to the start of the year, there is much more differentiation by credit quality and investors now require more spread for each additional unit of credit and default risk.
Figure 1. A widening gap
Source: Federated Hermes, ICE Bond Indices, as at May 2020.
Credit profiles are dynamic by their nature and each requires a case-by-case analysis. The key focus for investors – many of whom have had to re-underwrite all the credits in their portfolio since 21 February – is now liquidity, and an issuer’s ability to carry its current debt load at the new cash-generation level. This is all the more true in light of high-yield credit’s increased cyclicality.
There are some clear takeaways for investors from this earnings season. Given the uncertainty about when the global economy will reopen, sectors directly affected by the coronavirus pandemic lack visibility and full-year guidance. Companies remain focused on building liquidity buffers through primary markets, confirming credit lines, cancelling shareholder payments, delaying capital expenditure and carrying out cost-cutting programmes.
As the first signs that markets have started to normalise appear, it has also become increasingly clear that some capital structures are not viable in their current form. In an environment where dispersion is set to remain high, bottom-up credit skills will play an increasingly important role.