June 2020 – Nick Corbishley

Negative-Interest Rate Champion Bank of France Now Frets About Ballooning Corporate Debt

Central-Bank Forked-Tongue Syndrome.

All over the world, corporations have taken on huge piles of fresh debt to try to weather the crisis. Many of those companies — after years of interest rate repression that encouraged them to borrow — were already heavily indebted before the crisis began. This is particularly true of France, where corporate debt was growing at an annualized rate of 5.8% in February, before the virus crisis began, according to the Bank of France. In March, the rate of growth jumped to 7.1%. It then surged to 9.9 % in April.

Much of this new debt issued during the pandemic is guaranteed by the French state — to the tune of 70-80% in the case of large companies. Thanks to this support, as well as the ECB’s negative interest rate policy, corporate bond buying programs, and countless other interventions, that debt comes at minimal cost for most corporations.

The interest rates on French banks’ corporate loans averaged just 1% in April — the lowest level since 2003, according to French financial daily Les Echos. The yields on the bonds issued by French firms in April averaged 1.58%, significantly higher than the record low of 0.48% registered in August 2019 but a marked improvement on the 1.99% registered in March, when bond yields were soaring.

While debt is still relatively cheap for large French firms, despite the bleak economic panorama, the risks facing excessively leveraged companies are mounting, Bank of France (BdF) warned in its biannual financial risk report.

“The increase in corporate debt could hurt many (firms’) solvency and this risk could be made worse if the recovery is weak and their ratings deteriorate,” the central bank said. “A sharp increase in corporate bankruptcies could in turn increase banks’ non-performing loans, slowing the flow of credit necessary for the economic recovery.”

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Mall Giant Intu Collapses Into Bankruptcy

A zombie well before the pandemic, the UK company had racked up huge debts to finance rapid growth in a sector that had started shrinking some time ago.

Intu Properties, which owns 17 malls in the UK, including nine of the 20 biggest, and partially owns three in Spain, has fallen into administration, a form of bankruptcy under UK law, after talks with its myriad creditors collapsed on Friday afternoon. Worth £13 billion at its peak over a decade ago, Intu is Britain’s biggest corporate casualty of the virus crisis so far, though its problems predated Covid’s arrival. Its demise leaves 132,000 jobs, both at the company and in the thousands of stores it hosts at its malls, on the line, as well as some £4.5 billion of debt.

Intu had until 11:59 p.m. Friday night to convince seven of its lenders to accept yet more covenant waivers on £600 million of loans. But those lenders refused to be swayed. They knew that Intu, which had only managed to collect 10% of its second-quarter rents by the due date, according to sources cited by The London Evening Standard, would never be able to repay the debt it owed.

This year alone, the company had £190 million of debt maturing and £93 million of swaps payable, compared to £168 million of cash and £129 million of other available funding facilities. Things would get particularly hairy thereafter, with £920 million of debt coming due in 2021, followed by £780 million in 2022, £1.03 billion in 2023 and £670 million in 2024.

Mid-morning Friday, Intu reported that “insufficient alignment and agreement [had] been achieved on such terms.” Hours later, it announced it had appointed three administrators at KPMG.

Before that, the company’s shares nose-dived in a near-perfect straight line from almost worthless (four pence a piece) to nearly totally worthless (just over one pence a piece). In early afternoon, the Financial Conduct Authority decided to suspend the listing the shares. Shortly after, the London Stock Exchange suspended the trading of those shares, at which point the company’s market value was just £24 million.

“The significance of Intu’s collapse “cannot be understated,” said Richard Lim, chief executive of Retail Economics. The coronavirus lockdown is speeding up a trend towards buying more consumer goods online, he said. “It’s going to be a really, really tough challenge. There’s no getting away from the fact we have too much retail space.”

And many of the occupants of that retail space are no longer paying their rents. Commercial landlords in the UK received just 18% of what they were owed by their last quarterly rent collection date (June 24), according to data collected by Re-Leased, the cloud-based commercial property management platform. That’s even lower than the 24% collected by the March quarterly rent day, laying bare the growing pains being felt by commercial real estate tenants, particularly the non-essential retailers that were forced to close between March 23 and June 15.

Their loss has been e-commerce’s gain. After years of gradual incremental growth, online spending surged to new highs during lockdown. By May, online sales accounted for 33.4% of retail spending in the UK (unlike US retail figures, this measure does not include motor vehicles and pharmaceutical products), compared with 19.6% in February, according to the Office for National Statistics.

“In many ways, the pandemic is an accelerator, and will really have forced change that would have taken five years or more to happen now,” retail analyst Mr Hyman told BBC News.

The UK’s brick-and-mortar retail meltdown was already well under way before Covid’s arrival, as a toxic cocktail of factors — high rents, high business taxes, low profitability, online competition, low consumer confidence and spending power, among others — took its toll on both the high street and the mall. A total of 117,000 retail jobs were lost and 14,500 stores were closed in 2019 alone as a result of brick-and-mortar retail companies hitting the wall or simply cutting costs in a desperate bid to stay afloat, according to a report published by the Centre for Retail Research.

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Barcelona’s Epic Tourism Boom Is Over, Now the Crisis Begins: My Walk to the Beach

Owner of a small cafe that specializes in fine cakes and sandwiches tells me: “We’ll be lucky if we get half the normal number in July and August.” It’s now “all about damage control.”

Yesterday, my wife and I took our first walk to the beach since Spain entered lockdown almost three and a half months ago. From there, we meandered through El Born, which together with Sant Pere and Santa Caterina, forms one of the four barrios that make up Barcelona’s old town. El Born’s shaded cobbled streets and plazas are — or at least were — ground-zero for Barcelona’s bustling tourism trade. But that trade has been decimated by the virus crisis, and the streets of El Born are half empty, many of the hotels are still closed and an eerie quiet pervades the once-thronged plazas.

In some parts, there are already visible signs of crisis. As in the darkest days of Spain’s last housing crisis (2010-13), boarded-up shops, bars, restaurants and other street-level businesses are everywhere. In one narrow three-block street called Flassaders, I counted nine shuttered businesses. Eight were already up for rent. Here are some samples:

Spain’s biggest property website, Idealista, is currently advertising 244 retail properties in El Born, Sant Pere and Santa Caterina. They range from tiny little shops on tucked-away alleyways to sprawling bars, restaurants and stores on some of the barrio’s busiest thoroughfares.

After years of relentless gentrification, El Born was already in trouble before Covid arrived. Retail rents had reached levels that many businesses could no longer pay. Petty street crime, much of it targeting tourists, had become rampant, and in some cases violent. And many tourists had begun to explore other neighborhoods such as Gracia and Sant Antoni. The only way for shops and other businesses to pay their rents and still survive was to target big-spending foreign tourists. But now they’ve gone. And when they come back, it will be in smaller numbers and shallower pockets.

Facing the prospect of continued sluggish sales, many local traders in El Born, rather than taking out more debt to pay their rents, have simply shut up shop. Yet despite the glut of properties on the market, the rents being advertised are still absurdly high, suggesting that many of the property owners — most of them well-heeled local families — haven’t quite accepted that market conditions have changed dramatically.

In Spain’s last financial crisis, El Born, and Barcelona’s Gothic Quarter as a whole, escaped the worst of the fallout, thanks to the rapid recovery and resurgence of the tourism industry. This time, it’s the travel and tourism industries that have been sledgehammered by the covid-inspired lockdowns, travel bans and other restrictions, leaving barrios like El Borne and Sant Pere on the front lines of this new crisis.

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Massive Credit Losses to Hit European Banks in Q2 and into 2021, Particularly When Debt Moratoriums Are Lifted

But the ECB went into high gear to soothe the pain of the banks.

The second quarter results of most large Western European banks will reveal further increases in expected credit losses as the economic outlook has “weakened substantially since the publication of 1Q20 results”, Fitch Ratings warns in its latest “Large European Banks Quarterly Credit Tracker.” This will put substantial pressure on the sector’s operating profitability.

European banks already had a profitability problem before this crisis began. The last time that average return on equity (ROE) in the sector reached the 10% threshold, which is broadly considered a healthy minimum, was in 2007, when the shares of European banks were at the highest level they have ever been. Since then, the average ROE of European banks has not come even close to regaining that level.

ROE was negative in three out of the five years that followed the share-price peak in 2007: in 2008, 2011 and 2012, as most European banks reported negative net income. Many would end up going under and getting bailed out or being absorbed by one of their somewhat healthier rivals. ROE began edging back upwards in 2013, reaching an 11-year high of 7% in 2019.

But in the first quarter, Covid hit, forcing many banks to provision for expected credit losses (ECL), with the result that sector-wide ROE slumped to 4%. Many large banks reported sharp drops in profits. Five big banks — HSBC, Deutsche Bank, Unicredit, BBVA and Societe Generale — posted net losses.

In the second quarter, more banks could take a hit if so-called “loan-impairment charges” (LICs) — an amount that a bank sets aside in case its customers cannot make the required loan repayments — rise sharply, Fitch warns.

At the 20 banks in Fitch’s analysis, LICs almost tripled year on year in the first quarter, to around €24 billion, eating up more than 55% of pre-impairment operating profit (compared with less than 20% in 2019). Fitch estimates that approximately half of the LICs “resulted from expected credit losses amid weaker macro-economic forecasts and management overlays on specific riskier loan portfolios, including the most vulnerable corporate sectors and unsecured consumer finance” [such as credit cards].

In the first quarter, the banks did not report a notable rise in impaired loans. But the main reason for that is that the economic fallout of the lockdowns had barely begun. As Fitch warns, impaired loans are “likely to increase significantly” in the second half of 2020 and into 2021, particularly when debt moratoriums are lifted.

Bad loans are still a problem in many parts of Southern Europe, including Italy, Portugal, Greece and Cyprus, a long-lingering legacy of the last crisis. Warnings are also being issued about a sudden surge of non-performing loans (NPLs) in Eastern Europe. The “Vienna” Initiative, a European bank coordination framework set up in the wake of the last crisis with a view to safeguarding the financial stability of emerging economies in Central and Eastern Europe, warned this week that banks in the region will soon be hit by a wave of bad loans that may last beyond 2021.

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Latin-America’s Airlines Are Crashing, But There May Be No Bailouts. Aeromexico Denies Filing for US Bankruptcy

The AMLO government, which has refused to bail out shareholders and bondholders of large companies, could be on to something: A form of capitalism where investors, not taxpayers, carry the risks.

Mexico’s main airline, Aeromexico, on Friday felt compelled to issue a denial that it “has not initiated, nor has it made the decision to initiate, a restructuring procedure under Chapter 11 of the Unites States Bankruptcy Code,” following allegations to that effect in Mexico’s most widely read financial daily El Financiero. A few lines further down in the press release, the company said it is exploring ways to restructure, in an orderly fashion, its short- and medium-term financial commitments.

If the statement was meant to put investors’ nerves at ease, it didn’t quite work that way. Aeromexico’s shares ended the day 4.5% lower and are now down 60% year to date.

Investors are spooked for good reason. In May, the number of passengers on its domestic flights plunged by 89% from a year ago, and for international flights by 98%. Like all airlines, it desperately needs financial support to navigate the unprecedented turbulence hitting the aviation industry. And for the moment, it’s not getting it.

Like many airlines, Aeromexico was already in trouble before the virus crisis brought air travel to a near-standstill. In 2019, its CEO, Javier Arrigunaga, went cap in hand to Mexican President Andres Manuel Lopez Obrador’s right hand man, Alfonso Romo, to request a $125 million emergency credit line from Mexico’s state-owned development bank. The answer was a resounding no.

According to the article in El Financiero that forced Aeromexico’s bankruptcy enial, the airline is currently being advised by U.S. law firm White & Case and Citigroup.

Two of South America’s largest airlines, Santiago-based LATAM (a Chilean-Brazilian airline) and Colombia’s Avianca, have already filed for bankruptcy protection in a New York court. In May, LATAM became the world’s largest airline to date to seek an emergency reorganization due to the coronavirus pandemic. It seeks to restructure $18 billion in debt. Latam’s filing for Chapter 11 is likely to delay a proposed bailout of the company by Brazil’s state development bank as well as push back aid to its domestic rivals.

Avianca was already desperately weak before Covid struck, having emerged from a debt restructuring process in Dec. 2019. Like LATAM, Avianca’s revenues and earnings were decimated by the near-total collapse of passenger operations in April, as all countries in Latin America sealed their borders and barred all non-essential travel. Passenger traffic on Latin American and Caribbean airlines plunged by a staggering 96% in April, according to the International Air Travel Association (IATA).

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Italy Once Again on the Eurozone Worry List

A new tsunami of bad debts washes ashore while banks are still struggling with the debris from the prior tsunami of bad debts.

Over half of Italian companies reported facing a liquidity shortfall by the end of 2020 and 38% reported “operational and sustainability risks,” according to a survey of 90,000 companies conducted by Italy’s national statistics institute ISTAT.

The national Italian business lobby, Confcommercio, recently estimated that 60% of restaurants and other businesses were short on liquidity and 30% had complained about the extra costs of implementing anti-contagion safety measures so they can start serving customers after lockdown.

The tourism industry, which accounts for 13% of GDP and has been crucial in keeping Italy’s economy afloat over the past decade, providing jobs for an estimated 4.2 million people, is in post-lockdown limbo. The borders have opened but foreign tourists still remain elusive. And with many local residents in no financial position to go on holiday this year, domestic demand is unlikely to pick up as much of the slack as tourism businesses are desperately hoping.

Tourism was one of the few parts of the economy that has been growing in recent years. Last year, for instance, it grew by 2.8% while Italy’s industrial output shrank by 2.4%. In an economy that hasn’t grown for well over 10 years while public debt continues to grow at a frightening rate, its fastest growing sector has just been hit with the mother of all sledgehammers.

Italy’s manufacturing industry, which was already struggling before the crisis, is also in trouble. In April, when Italy was in the grip of one of the most severe lockdowns in Europe, ISTAT’s industrial turnover index plunged by 46.9% while the unadjusted industrial new orders index fell by 49.0% with respect to the same month of the previous year. Since then, many businesses have reopened but activity remains low.

To weather the lull, many companies need credit. But this is easier said than done in Italy, unless you’re a multi-billion dollar company. Car giant Fiat Chrysler is on the verge of being granted a €6.3 billion state-backed loan — more than any other European carmaker. Even Atlantia, the firm that operated and maintained the Morandi Bridge in Genoa that collapsed in 2018, resulting in 43 fatalities, is hoping to hit up the government for a €1.7 billion loan.

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Commercial Real Estate Sellers Expecting Pre-Virus Prices “Are Smoking Dope,” Says UK Fund Manager

Capital values across all segments (retail, office, industrial) already fell by 6.1% over the three months from March to May.

If you’re a commercial property fund manager in the UK and you think you’ll be able to fetch pre-lockdown prices for properties you need to sell, you’re “smoking dope”, according to Schroder Real Estate fund manager Duncan Owen. Owen believes that valuations of UK commercial property have at least another 10% to fall. His comments come as close to a dozen open-end mutual property funds, with roughly £12 billion in assets, remain suspended after gating en masse in March, leaving hundreds of thousands of retail investors unable to access their money.

These funds are “forced sellers.” They are not selling out of choice but rather out of the need to raise cash as quickly as possible in order to be able to reopen their doors and meet redemption requests. When there are lots of forced sellers in a market — especially big funds that were until recently big buyers that helped drive up prices — it means that prices are now headed down.

Owen, who is head of global real estate at Schroders and jointly manages the Schroder Real Estate Investment Trust, said that while “deal flow has considerably increased” over the past month, the prices being asked by sellers did not reflect the impact of the lockdown and its aftermath.

“Vendors are smoking dope,” he said. “They are asking for [pre-virus] prices and they are not going to sell at those prices.” Owen added that for firms on the lookout for new purchases, there is “no urgency” to buy as “the market will soften,” predicting commercial property had “another 10% to fall and retail maybe another 20%.” The fund has made no bones about the fact it is looking to reinvest after a sharp market correction.

Given the sheer scale of economic carnage the virus crisis has unleashed and the uncertainty that continues to grip financial markets, it’s still too soon to gauge how commercial real estates prices are responding. In fact, this is the official reason why the open-end funds were shuttered in the first place, and remain so: the “material uncertainty” caused by the crisis left valuers unable to accurately value 20% or more of the assets within the property funds. The unofficial reason is that many of the funds’ spooked investors staged a mad dash for the exits.

The retail segment of commercial real estate has been particularly hard hit, as many retailers, including big chains, have stopped paying their rents, cranking up the pressure on already struggling retail landlords. Many landlords have seen their income fall by as much as two-thirds since the crisis began.

Demand for office buildings is also at risk as companies come to terms with the fact that many of their workers can work from home. While new social distancing rules will increase the need for space for those workers who stay on in the office, it’s not clear whether it will make up the difference. In recent days, Lloyds Bank became the latest FTSE 100 company to warn that it would probably “need fewer buildings and different types of spaces” in future.

With rental income from retail properties plunging and demand for office buildings waning, at the exact same time that the market is witnessing a glut of those exact same properties as open-end property funds cash out, the values of those properties are coming under pressure.

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Europe’s Fashion Industry Faces Nightmare

“People do not buy a new outfit to stay at home.” Sales at stores that have reopened languish while ecommerce is booming. McKinsey: up to a third of global fashion retailers will not survive the crisis.

Most European brick-and-mortar clothing stores have been open for three or four weeks, yet sales continue to languish. In April, when all but the essential brick-and-mortar stores were shut, sales of clothing and accessories slumped by 50% in the UK and 67.4% in France, the home of fashion. In Spain, revenues in the sector plunged by 80.5%, according to data published by the trade association Acotex.

But even in May, when stores in most Spanish cities reopened, revenues in the sector fell 72% year over year and are down 45% year to date. Those figures include booming online sales.

“The textile and accessories trade is in a very delicate spot, requiring urgent and specific measures for the sector,” warned Acotex. In other words, government help and money. Otherwise, the trade association said, there will soon be a wave of bankruptcies and closings.

The problem is not just that people have been unable to visit their favorite clothing stores in recent months, it’s that they’re less likely to add to their wardrobe at a time of much reduced socializing, and in many cases reduced income. As Simon Wolfson, CEO of UK fashion retailer NEXT, said, “People do not buy a new outfit to stay at home.” And much of what they do buy, they now buy online.

On Wednesday, Inditex, one of the world’s largest fashion retailers with with eight brands, including Zara, and nearly 7,500 stores in 96 countries (at the end of 2019), reported a 44% plunge in revenues in its first quarter, February through April, to €3.3 billion from nearly €6 billion a year ago, and a net loss of €409 million, its first quarterly loss since going public in 2001. The company’s shares fell 9% on the week and are down 23% year to date.

But online sales have surged 95% in April and 50% in the first quarter. Inditex says it expects online sales to represent more than 25% of total sales by 2022, up from 14% at the end of 2019.

At the end of April, only 965 of Inditex’s stores were open in 27 countries, about 13% of total capacity. But in May, despite seeing “a progressive recovery in sales in the markets that have reopened stores,” total sales in local currencies (including booming online sales) were still down by 51% compared to the same month last year.

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Tsunami of “Unsustainable” Business Loans to Hit Banks, City of London Grandees Warn

“Consideration may need to be given” to bailouts from taxpayers “to meet solvency or liquidity requirements,” but only “at the extreme end,” whatever that means.

Many struggling businesses in the UK, both large and small, will soon be sitting on debt piles they won’t be able to service as the emergency loans they’ve taken out to survive the lockdown and its aftermath begin to fall due. That’s the stark warning of an “interim report” by the Recapitalisation Group (RCG), a task force assembled by The CityUK, one of the UK’s most powerful financial lobby groups, at the “encouragement” of the Bank of England, to explore ways of recapitalizing small and medium-size enterprises (SMEs) when the inevitable debt defaults begin.

By early next year, non-financial businesses will have between £32 billion and £36 billion of additional debt they cannot repay, the RCG warns in the report. That fresh debt, on top of the distressed business debt that already existed before the crisis, will leave UK businesses with between £97 billion and £107 billion of what the RCG calls “unsustainable debt.”

Around half of that debt will belong to SMEs. Almost all of it will be owed to banks. Although the loans are ostensibly backstopped by the government, some banks, according to The Sunday Times, are beginning to fret that when companies begin to default on their debt, the government backstop will not automatically kick in, leaving the banks holding big losses on their loan books.

The UK government has set up a total of three emergency business loan programs in response to the coronavirus crisis: the Bounce Back Loan Scheme (BBLS), the Coronavirus Business Interruption Loan Scheme (CBILS), and the Coronavirus Large Business Interruption Loan Scheme (CLBILS), each of which covers different segments of the business community.

BBLS is aimed at micro and small businesses, offering facilities of up to £50,000. It is 100% backed by the government. CBILS is tailored to both small and medium sized businesses, offering facilities of up to £5 million, and is 80% backed by the government. CLBILS focuses on large businesses with facilities of up to £200 million and is 70% government guaranteed.

In addition, the Bank of England has launched the Covid Corporate Financing Facility program which provides liquidity to large corporations by exchanging commercial paper for low-interest loans. It has so far lent £16 billion to 53 companies.

But it’s the government’s three loan programs the RCG is interested in. Through these programs, lenders have provided £35 billion in emergency loans to 830,000 businesses. But the RCG expects this to rise to between £111 billion and £123 billion by the second quarter of next year.

Borrowers do not have to repay the principal or interest on those loans for the first 12 months. But in three months’ time the government’s job retention scheme is scheduled to come to an end, meaning companies will have to restart paying the wages of their formerly furloughed workers. That could be a stretch for some companies that have generated virtually no revenues for months on end and will need to use much of their working capital to reinvest to meet pent up new demand. The alternative is to lay some of their workers off, but that itself can be a costly process.

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The 53 Companies Bailed Out by the Bank of England: Johnson Controls, Carnival, PACCAR, Honda, Toyota, BASF, Bayer…

Foreign Companies welcome. US Tax dodgers that didn’t qualify in the US, no problem.

The Bank of England (BoE) published a list of the 53 companies to whom it has lent more than £16 billion, at absurdly low rates, as part of its Coronavirus Corporate Financing Facility (CCFF). Launched on March 20, the scheme enables the BoE to buy short-term corporate debt (“corporate paper”) of up to one-year maturity from companies at interest rates of between 0.2% and 0.6%.

To qualify for these funds, you need to be a large company that is adjudged to have been in sound financial health before the coronavirus outbreak but is now facing acute short-term cash flow problems as a result of that outbreak. Your debt must also be rated investment grade at the time of the loan application.

You do not need to be a British firm to qualify for the loan program; you just need to be deemed to provide “a material contribution to the UK economy.” Around two out of five of the recipients are headquartered overseas and the program’s biggest beneficiary so far is German chemicals giant BASF, which was given a loan of £1 billion. Another German company, Bayer (infamous for having acquired Monsanto to then get swamped by Monsanto’s horrendous litigation), also received £600 million.

Many of the loan recipients are in the sectors hardest hit by the fallout of the coronavirus crisis:

Aviation.

So far, the biggest recipients of state aid in Europe are airlines such as Lufthansa and Air France-KLM. Some airlines are also getting help from central banks. In the case of the Bank of England’s CCFF program, four companies have received a total of £1.8 billion in short-term loans: British Airways (£300 million), Ryanair (£600 million), Easyjet (£600 million) and Hungarian low-cost carrier Wizz Air (£300 million).

Ryanair is a particularly interesting case given that it has €4.1 billion in cash reserves. As such, it is not suffering short-term cash-flow difficulties. What’s more, its owner, Michael Leary, has made a huge song and dance about the injustice of his cash-flush airline having to compete with flagship carriers primed with bailout cash, which is a perfectly justifiable point if it wasn’t for the fact that at the same time Leary was badmouthing his rivals, his company was also receiving a virtually free loan of £600 million from the BoE.

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