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Fiscal firepower: shock and awe in fixed-income markets

Governments have proposed a raft of initiatives to protect businesses and their employees from the impact of the coronavirus pandemic, while banks are being used to inject liquidity into the economy – something that will have material implications for credit markets. In the latest edition of 360°, our fixed-income quarterly report, we discuss the impact of these changes and take a closer look at the structured-credit market.

Pandora’s box: opening the fiscal coffers   

Since the coronavirus pandemic erupted, we have witnessed an immense, rapid and coordinated intervention in markets. Central banks and governments are battling against the turmoil caused by the virus, and the rulebooks for support have been rewritten (if not completely torn up). 

Monetary easing from central banks has been accompanied by an equally monumental fiscal response from governments. This includes changes to lending rules, wage subsidies, tax relief, grants, loans, bailout packages and universal income. 

Coronavirus crisis: banks lead the charge  

The banking sector, wider lending community and governments are helping companies and citizens weather the volatile economic climate. Measures used will support credit markets as they should provide a cushion against the inevitable spike in defaults.

Unlike in 2008, the current crisis has not emanated from weakness in the banking sector. As a result, authorities have moved to protect banks from the impact of the downturn and have maximised their ability to inject liquidity into the real economy.

Most regulators have followed the recommendation of the European Central Bank’s supervisory arm to ban banks from paying a 2019 dividend, which should generate an additional €30bn of capital for European banks. The UK has also followed suit with a similar request.

This move benefited credit markets, as it protects the capital position of banks. Payment of additional tier-one coupons have not been affected by the decision, although this could change if the situation deteriorates significantly. 

Banks have led the way in providing liquidity to the real economy, primarily through draws on revolving credit facilities (RCFs). This is different to 2008, when borrowers were reluctant to draw their RCFs and in some cases struggled to do so. Draws on RCFs are increasing daily and banks are shouldering the initial injections of cash into the world economy – something that reinforces the liquidity position of borrowers.

Banks and alternative lenders are also under heavy pressure to behave responsibly towards borrowers. Interest holidays have been applied in a number of European markets, where interest payments have been added to the capital value repaid at maturity and term-loan A amortisation payments have been cancelled. Generally, lenders are supporting portfolio companies that were performing before the crisis.

Governments have reinforced these initiatives with a number of national funds to support companies. Countries with significant social-support infrastructure – such as Belgium and the Nordic nations – have funds in place which support the liquidity of businesses, rather than their employees. Other countries also aim to support corporates through loan-guarantee schemes and liquidity facilities. 

Structured credit: in the firing line 

The structured-credit market is the eye of the storm. Most European securitisation is backed by loans to consumers – such as residential mortgages, car loans and credit cards – which means the drop in economic activity and decline in personal incomes has diminished the ability of consumers to reduce their debts.