Global Policy Response

Global Policy Response

Nobody ever regrets making fast and decisive adjustments to changing circumstances. In downturns, revenue and cash levels always fall faster than expenses. Moreover, a distinctive feature of enduring companies is the way their leaders and countries leaders react to moments like these. All in all, as with all crises, there are some businesses that stand to benefit. However, many companies in frontline countries are facing challenges as a result of the virus outbreak, including drop-in business activity, supply chain disruptions and curtailment of travel and canceled meetings. The global policy response to challenges:

The WHO and other global health officials have emphasized the significant limitations of closing borders and quarantines as an effective policy response.

The effectiveness in pivoting the healthcare response from quarantines to “maximum containment” and “treatment” is unclear.

Monetary policy has significant limitations to meaningfully mitigate supply chain disruptions.

Financial conditions, which tightened sharply this week, have dislocated from rates markets, and have been largely unresponsive to the 5 declines in global rates to multi-century lows.

Monetary tools tend to be less effective in the presence of elevated uncertainty.

Rate cuts will adversely impact bank sector profitability and households, especially in Europe.

The feedback loops between demand shocks, supply dislocations, and financial risk will require a large and globally coordinated policy response across multiple dimensions. Moreover, that includes liquidity and lending incentives for banks. In addition, supply chain finance, credit support for SMEs and highly impacted industries. Debt moratoriums targeted QE for highly impacted sectors, consumer healthcare relief, and so forth.

With benchmark policy rates so low in developed countries (Fed, ECB, BOJ), and fiscal deficits so high in the US and China, the policy toolkit may be less flexible than in prior recessionary risk periods.

Global Policy Response to pandemic
Source: RaboResearch, IMF, Macrobond

China has started to deploy a targeted fiscal stimulus package. However, with several years of rising fiscal deficits, China’s macro toolkit has become more constrained.

Monetary policy response measures to Coronavirus: 10 bps PBoC rate cut (earlier than expected), RMB 300 bn re-lending facility to encourage bank lending, RMB 200 bn liquidity injection vial MLF, jointly introduced measures from the PBoC, MoF, CBIRC and SAFE to ensure liquidity within system and support medical and pharmaceutical industries, moderate RMB depreciation through 7.0 threshold.

Fiscal stimulus measures thus far have been through targeted programs: RMB80 bn in “Epidemic Prevention Fund”, tariff suspension on materials used directly for epidemic control. Counter-tariff reduction on some US imports to help importers, 50% interest subsidy to firms affected by virus outbreak, 20+ measures to support SMEs. Those include support for factory re-openings, delay utility payments, rent deductions, tax deductions & delays, delays/refunds social security contribution, etc.

Global Policy Response China index
Source: Macrobond, RaboResearch, China Federation of Logistics, NBS

Front-loaded local government bond quota, delayed pension, jobless and work-injury insurance payments for companies in Hubei, cut power price by 5% for low energy consuming companies, flexibility for banks to not recognize some new bad loans during the outbreak and ordered not to reduce lending to businesses in impacted provinces.

Fed rate cut to now pricing nearly four cuts by year-end. The market is currently pricing nearly 4 full Fed rate cuts by the end of 2020.

Global Policy Response to covid-19
Source: DB Global Markets Research “Focus Europe – Coronavirus: Italy Suffers an Outbreak

COVID-19 Facts and Insights

COVID-19 Facts and Insights

COVID-19 is, first and foremost, a global humanitarian challenge. The covid-19 facts and insights are showing the reality of the health system and how the world is battling this crisis. Thousands of health professionals are heroically battling the virus, putting their own lives at risk. Governments and industry are working together to understand and address the challenge, support victims and their families and communities, and search for treatments and a vaccine. Companies around the world need to act promptly.

There are two possible Epidemiological scenarios. Delayed recovery: The virus continues to spread across the Middle East, Europe, and the US until mid-Q2 2020 when virus seasonality combined with a stronger public health response drives caseload reduction.

Prolonged contraction: The virus spreads globally without a seasonal decline, creating a demand shock that lasts until Q2 2021. Health systems are overwhelmed in many countries, especially the poorest, with large-scale human and economic impacts.

Also, there are two economic impacts. China and East Asian countries start recovery but supply chains remain impaired US and Europe large – scale quarantines, travel restrictions, and social distancing drive drop-off in consumer spending and business investment in 2020.

China and East Asia experience double-dip slowdowns as economic recovery is derailed in 2020 and pushed into Q1 2021 The United States and Europe experience demand-side reductions in consumer and business spending and deep recessions in 2020.

Covid-19 facts
Source: Bloomberg

The COVID-19 outbreak has generated both demand and supply shocks reverberating across the global economy. Among major economies outside of China, the OECD forecasts the largest downward growth revisions in countries deeply interconnected to China, especially South Korea, Australia, and Japan.

Major European economies will experience dislocations as the virus spreads and countries adopt restrictive responses that curb manufacturing activity at regional hubs, including in Northern Italy. As a result of depressed activity, the United Nations projects that foreign direct investment flows could fall between 5 and 15 percent to their lowest levels since the 2008-2009 global financial crisis.

At the sectoral level, tourism and travel-related industries will be among the hardest hit as authorities encourage “social distancing” and consumers stay indoors. The International Air Transport Association warns that COVID-19 could cost global air carriers between $63 billion and $113 billion in revenue in 2020, and the international film market could lose over $5 billion in lower box office sales.

The COVID-19 Facts

Similarly, shares of major hotel companies have plummeted in the last few weeks, and entertainment giants like Disney expect a significant blow to revenues. Restaurants, sporting events, and other services will also face significant disruption. Industries less reliant on high social interaction, such as agriculture, will be comparatively less vulnerable but will still face challenges as demand wavers.

Covid-19 forecast for 2020
Source: International Energy Agency

Economic slowdowns generally lead to lower energy demand, and the fallout from COVID-19 has proved no different. Often, producers respond to demand slumps by cutting supply to buoy prices. The damage from the Saudi-Russian price war sends an unsettling signal to markets hungry for a coordinated policy response to the epidemic, especially considering Saudi Arabia’s current role as G20 president.

Therefore, in response to the price shock, large oil producers, including firms, could pare back investment and production, with heavily indebted firms in particular at risk of layoffs, consolidations, and even bankruptcy.

Thus far, national governments have announced largely uncoordinated, country-specific responses to the virus. In China, the epicenter of the outbreak, officials announced billions in special-purpose loans to companies facing liquidity constraints as well as financial support to specific sectors such as aviation.

In the United States, the Federal Reserve cut the policy rate in an emergency action on March 3, and on March 9, in coordination with other U.S. bank regulators. It encouraged financial institutions to meet the financial needs of customers and members affected by the coronavirus. That being said, this is a move aimed at supporting financial conditions to prevent the growth shock from turning into a broader financial crisis.

Moreover, in regards to coordinated action, on March 6, the G20 finance ministers and central bank governors pledged to take “appropriate” fiscal and monetary measures but made no specific commitments.

Scientists do not yet have a clear understanding of the virus’s behavior, transmission rate, and the full extent of contagion; uncertainty will be part of the backdrop for the foreseeable future. Coherent, coordinated, and credible policy responses provide the best chance at limiting the economic fallout from what is already and sadly a human tragedy.

COVID-19: Market Implications

COVID-19: Market Implications

The stock market has responded to the COVID-19 pandemic with worrying volatility, as traders have panic-sold out of fear. As a result of the recent turmoil, the market-wide circuit-breakers that attempt to prevent panic-trading, have been triggered four times alone in March. The market has reacted to recent unpredictability with large drops, triggering a market-wide circuit breaker four times in March. The safeguard pauses trading for 15 minutes in hopes the market will calm. The coronavirus has created such uncertainty around the world that two of the largest single-day drops in the Dow Jones Industrial Average have been from March of 2020.

The negative superlatives for American stocks are piling up. The S&P wiped out its gain in 2019 and is now down almost 30% from its all-time high. The Dow Jones Industrial Average lost almost 13%, falling 3,000 points to close at a two-year low. The Russell 2000 had its worst day on record, losing more than 14%. While the Fed cut rates toward zero and stepped up bond-buying, investors continued to clamour for a massive spending package to offset the pain from closures of schools, restaurants, cinemas and sporting events. Companies around the world have scaled back activity to accommodate government demands to limit social interaction.

S&P Financial Values – covid-19

Source: Yahoo Finance

The Fed and other central banks have dramatically stepped up efforts to stabilize capital markets and liquidity, yet the moves have so far failed to boost sentiment or improve the rapidly deteriorating global economic outlook. An International Monetary Fund pledge to mobilize its $1 trillion lending capacity also had little impact in markets.

Source: EM equities is the MSCI EM equity index. Commodities are SPGSI Index.

The pan-European Stoxx 600 provisionally closed 5.1% lower, off lows hit earlier in the session. Travel and leisure stocks plummeted around 10% to lead losses as all sectors and major bourses ended the day in the red. Spain’s IBEX was around 8.3% in the red and Italy’s FTSE MIB was down over 6%. France’s CAC 40 provisionally ended 5.9% lower. Germany’s XETRA DAX closed 5.3% in the red as the U.K.’s FTSE 100 finished 4.7% lower.

Source: Bloomberg. Data as of February 28, 2020. Currency axis inverted to show appreciation

Airlines and travel companies continued to suffer on Monday, although by the end of the day had pared some losses. Tui shares ended down around 13%, EasyJet shed 19%, Air France KLM fell 10% and British Airways parent IAG tumbled 27% after hitting 52-week lows. In the meantime, global investors will seek the safety and liquidity of USD assets, gold and safe haven currencies (Swiss, Yen).

In addition, please read more about covid-19 financial and private equity impact on global markets.

CESEE coronavirus economic impact: How bad will it get?

CESEE coronavirus economic impact: How bad will it get?

Planet earth is shutting down. In the struggle to get a grip on coronavirus, CESEE countries are hit the most. One country after another is demanding that its citizens shun society. As that sends economies reeling, desperate governments are trying to tide over companies and consumers by handing out trillions of dollars in aid and loan guarantees.

A lot of countries and firms will run into financing difficulties. The difference between difficulties and outright collapse depends heavily on central banks, IMF and other international lenders. The role of wealthy governments and big central banks is central. They have the resources to tackle this. H1 recession could be among the deepest of all time. Full recovery H2 2021 and into 2022. However, when the recovery comes, it should be strong.

Source: Chinese authorities

A lot of countries and firms will run into financing difficulties. The difference between difficulties and outright collapse depends heavily on central banks, IMF and other international lenders. Therefore, the role of wealthy governments and big central banks is central. Besides, they have the resources to tackle this. H1 recession could be among the deepest of all time. Full recovery H2 2021 and into 2022. However, when the recovery comes, it should be strong.

Forecasts for Central, East and Southeast Europe (CESEE)

Source: Annual Database incorporating national and Eurostat statistics.

Italy has an export-oriented economy and is the 9th largest exporter and 11th largest importer worldwide, with trade making up nearly 59.5% of its GDP (World Bank, 2019). According to data by ISTAT, out of a total of 195.745 exporting companies in Italy, around 45% are active in the manufacturing industry, which has traditionally been the key sector for Italian exports (especially for machinery, fashion and luxury goods, furniture). The country’s main exports include medicaments, cars and vehicle parts, refined petroleum, trunks, suit-cases, vanity-cases, and footwear. Italy is also the second-largest wine exporter in the world.

The country is dependent on imports for its energy needs, hence petroleum and gas products are among the main items in Italy’s import bills, together with cars and medicaments. Therefore, when we are talking about CESEE countries, the main partners are Albania and Slovenia with nearly 20% of external trade. The main countries of origin for Italian imports are Albania, Slovenia, and BiH.

Source: wiiw forecast

If China is a guide, it could be easily looking at contractions of 3-4% in 2020 for a lot of CESEE. That being said, for some could be much lower, and possibly even worse than 2009. Quality of health systems and fiscal space will be key (Ukraine example). Full bounce back unlikely to come until H2 2021. This table is a highly optimistic ‘best case’ scenario.

Besides, the spread of the coronavirus to Europe is already impacting production networks, tourism, aviation, and energy. The extent of the fallout is still highly uncertain but all face recessions. The capacity to cope depends heavily on the quality of the healthcare system and fiscal space, big differences within CESEE. Ukraine, Turkey, parts of Western Balkan will be most affected, much of EU-CEE should fare better.

COVID-19 impact on private equity markets

COVID-19 impact on private equity markets

The impact on private equity markets will level economic hardship. The coronavirus (COVID-19) outbreak is causing widespread concern and economic hardship for consumers, businesses, and communities across the globe. The situation is changing quickly, with widespread impacts. Most companies already have business continuity plans, but those may not fully address the fast-moving and unknown variables of an outbreak like COVID-19. Typical contingency plans ensure operational effectiveness following events like natural disasters, cyber incidents, and power outages, among other crises.

They don’t generally take into account the widespread quarantines, business and community disruptions, extended school closures, and added travel restrictions that may occur in the case of a health emergency. The S&P Listed Private Equity Index is crashing faster than the S&P 500 Index. The Index is designed to provide tradable exposure to the leading publicly listed companies that are active in the private equity markets and space.

private equity markets index
Source: Pitchbook

Private Equity (PE) firms may be facing a situation in which they have multiple underlying companies with hundreds or thousands of employees looking for guidance and direction during this crisis. While cybersecurity is always a top priority for PE firms and their portfolio companies, they may face additional threats and vulnerabilities now. This is because they will have significantly higher levels of remote access to core systems, along with employees and management who could be more susceptible to social engineering efforts in the midst of a crisis.

Portfolio companies often don’t have the HR expertise and infrastructure required to manage during a crisis, so they may seek guidance from their PE sponsors to help them effectively address workforce issues. PE firms should leverage their resources to provide necessary guidance to their portfolio at scale. Without the right monitoring and planning, PE firms could be overloaded with issue after issue, causing a fire drill every time. Additionally, HR policies and directives may be inconsistent within and across the underlying entities.

The crisis may not hit every geography equally. In areas that have been particularly hard hit, PE firms could be trying to adapt quickly to new rules and deadlines. In other areas, they may still need to comply with traditional filing and compliance deadlines. PE firms should also evaluate how an impact on operations of the portfolio company (from a reduction in normal operations, business interruption or non-recurring expenses) may be treated from an indenture perspective in their lending agreements. Depending on the potential add-back, they may need to track and monitor those costs and losses.

Generally speaking, private equity firms do not allow redemptions, thereby avoiding investor issues that affect other fund classes. However, investors can demand full transparency when it comes to a PE firm’s actions in this crisis. In dealing with COVID-19 issues, PE firms could lose sight of basic investment company issues, such as commitment call deadlines, financial statement filings, and shareholder updates.

Some portfolio companies in healthcare or retail are part of the frontline response or provide critical products and services; ensuring that their supply chains are operating at peak performance is essential. Others (such as travel and hospitality companies) are experiencing immediate and unthinkable drops in consumer demand. Since most sponsors have limited resources to share with their own companies (such as liquidity, operating executives to provide leadership and execution support, and critical relationships with other organizations), they will need to decide where best to allocate time and resources.

Private Equity Markets in 2019

As of the end of 2019, more than 75% of PE deals included debt multiples greater than six times EBITDA, a stark difference from that same figure following the GFC, which came in at around 25%, according to a recent report from Bain & Company.  With tighter lending, PE firms will be forced to enter transactions with more conservative capital structures that include a larger equity proportion. That said, funds are indeed better positioned to do that than ever before. In 2019, capital committed to PE alone grew 20% YoY to $1.3 trillion. Private debt funds were also sitting on record capital bases ($275.0 billion) by year-end, which should be paramount for middle-market transactions and companies.

private equity markets strategy
Source: Pitchbook

A combination of tighter and more scrutinized lending markets, in addition to depressed earnings and cash-flow profiles, will pressure companies. As economic activity subsides, we still expect to see an enhanced risk premium in the types of leverage and debt solutions used by PE, which will drive yields in those pockets higher despite the central bank’s actions to depress overall rates. Thus, as we see earnings fall and the cost of capital rises, asset prices will decline across the board, hurting exit multiples. PE vehicles will be forced to inject more liquidity into portfolio companies, reducing the leverage that provides the enhanced returns in the LBO market. Holding periods increase as firms will be forced to hold struggling assets and may find exit markets to be completely subdued for most assets, particularly across the strategic M&A and IPO avenues.

While there may be a pullback in fundraising (as some PE analysts predicted entering the year), we do not anticipate a dramatic downturn. We also do not foresee panic-selling in the secondaries market. Smaller firms are naturally more susceptible to a downturn, particularly generalists without a differentiated strategy. Consolidation within PE has led to large asset managers with multiple platforms that can still capitalize on a range of opportunities in a variety of economic environments.

The IPO market underpinned record VC exits in 2019, but that seems unlikely to repeat in 2020, with several high-profile listings rumored to be delayed. In PE, GPs are less willing to part with choice assets in a bear market. We expect to see more special-purpose continuation vehicles and GP-led secondaries funds. Today, a higher proportion of LBO financing comes from dedicated direct lending funds (as opposed to banks). While banks are likely to pull back in a recessionary environment, private debt funds are likely to continue investing through a downturn.

After taking initial actions to recover and stabilize, portfolio companies can prepare for growth in private equity markets. In the last downturn, many portfolio companies had success by investing at greater rates than their competitors. Portfolio companies should also prepare for M&A. Public companies that outperformed coming out of the last recession divested underperforming businesses faster than others did and made acquisitions earlier in the recovery phase. Portfolio companies can utilize a similar strategy by planning and executing a through-cycle strategy for M&A and divestitures and by building a pipeline of potential strategic targets.

We also covered a more broad approach to global economies and impact o private equity markets.

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