The pandemic and the credit spectrum

Mar 31, 2021
  • BlackRock

More than meets the eye

Just over a year into the pandemic, market conditions and credit valuations have improved significantly. A 20% selloff as lockdowns began soon reversed and credit markets have gone on to rally over 34% since the low point in March 2020, based on the Bloomberg Barclays US High Yield Index.  Roughly US$ 4 trillion of global corporate debt was issued in 2020, per BlackRock Capital Markets, and private debt funds closed on US $118 billion during 2020, according to Preqin. Behind the headline numbers, however, a more complex story is unfolding as long-running market trends intersect with Covid’s economic consequences. In the decade before the crisis, the segments of the credit markets—private, public, high yield, investment grade—grew deeper and more specialized as well as more integrated. Issuers could increasingly seek out capital on terms aligned with their needs, while investors gained more choices in risk and return profiles. Now the pandemic’s uneven impact across industries is creating a greater demand for non-traditional forms of financing on the private side of the spectrum.

Beyond dispersion

As the chart below reminds us, there has been a sharp dispersion between industry sectors hit hardest by Covid and those benefiting from it. For some companies, the parts of the credit spectrum available to them have changed, or the terms and prices in familiar segments have grown less attractive. Companies in leisure and travel have done sizable high-yield issues, but at generous spreads. Meanwhile, some issuers that could access the traded markets may opt instead for the scale and flexibility of the capital now available from direct lenders in private markets, or tap both public and private markets at the same time. Growth companies can continue to take advantage of private debt financing to stay private for longer. And companies facing turnaround situations or other complex challenges can partner with a specialized credit provider on a bespoke solution.

An uneven recovery

Returns for leveraged loans across industry sectors

Source: S&P LCD and BlackRock as of 28 February 2021. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results.

Source: S&P LCD and BlackRock as of 28 February 2021. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index.

Future credit needs

While credit markets will likely see a robust economy and strong demand from yield-hungry investors, some issuers may still face challenges. A recovery that is V-shaped for some could be L-shaped for those in sectors hit hardest by the pandemic. Additional hurdles may include the need to redesign and right-size business models, and to implement shorter and more resilient supply chains. Heightened leverage levels could be a constraint. Among companies in the S&P LSTA leveraged loan index, for example, leverage went from under five times earnings at year-end 2018 to more than six times at year-end 2020, according to S&P LCD. We expect plenty of activity across the credit spectrum this year, with private markets taking on a growing number of complex financing challenges.

Quotation start

While credit markets will likely see a robust economy and strong demand from yield-hungry investors, some issuers may still face challenges.

Quotation end

Original work, industry knowledge—and partnership

To invest well in one part of the credit spectrum, we believe it’s important to be active in all of them. For one thing, companies tap different parts of the market as they evolve. Today’s direct lending borrower may be tomorrow’s high-yield issuer, and yesterday’s high-yield issuer may be tomorrow’s bespoke-solution seeker, looking to repair the damage inflicted by the pandemic. Knowing the industries and the companies that comprise them, and interacting with the companies over time and changing circumstances, builds confidence and trust. The more bespoke the credit, the deeper the company-level due diligence needs to be, and the more important it is to reflect the diligence in how the credit is structured. Complexity is an opportunity, but it requires original work and a willingness to dive deep in order to identify the diamonds in the rough.