JPM Decorative Letter - Watermark J

Market Volatility Continues to Surge as Virus Escalates

J.P. Morgan's Corporate Finance Advisory examines key questions around economic uncertainty and heightened volatility that have emerged amid the global pandemic.

March 27, 2020

Over the past few weeks, market volatility has spiked to November 2008 levels and the U.S. equity markets have seen the largest single-day drop since 1987’s Black Monday, resulting in all U.S. global indices entering bear market territory. Here, J.P. Morgan’s Corporate Finance Advisory answers some key questions surrounding COVID-19’s market impact.

How Has Heightened Volatility Impacted Capital Markets?

Overall issuance has significantly declined across both debt and equity markets, with some parts of the market remaining closed for new issuance. However, compressed valuations has spurred increased interest in debt and equity repurchases, with liquidity preservation remaining a key consideration.

In debt capital markets, spreads have widened approximately ~250 to 700 basis points across investment grade, high yield and leveraged loan indices. Companies with access to the investment grade market are actively raising capital, since all-in coupons remain attractive in the historical context, with wider spreads offset by lower Treasury rates. High yield issuance has largely come to a halt, but strong investor cash balances are expected to be supportive when deals eventually come to the market. Hedging has surged, with many companies entering into rate locks and deploying strategies to capture low interest rates for future issuances.

Equity Capital Markets have seen a drop-off in IPO activity, but an increase in the equity-linked market. This heightened activity in the equity-linked market can be attributed to attractive terms, such as low Treasury rates and heightened volatility; this deal momentum is expected to continue.

Is COVID-19 Prompting Rating Agencies to Reassess Corporate Credit Risk?

Yes, and what started in the most affected sectors is now impacting all industries.

Rating agencies are assessing COVID-19’s overall impact on the economy, particularly to debt issuers. Moody’s and S&P expect that the first two quarters will result in a sharp economic contraction, which has recently led each of them to lower their 2020 U.S. GDP forecasts to -2.0% and -0.5%, respectively. S&P has even gone as far as stating that the current trajectory of COVID-19 has led them to believe that the U.S. is entering into an economic recession.

A number of sectors with strong links to either consumer discretionary spending or overall economic activity are under elevated levels of scrutiny. Downgrades and sector outlook changes started with industries and issuers most impacted by COVID-19. However, recent changes are also impacting other sectors, as agencies evaluate the knock-on effect of an economic slowdown on issuers not in sectors immediately impacted. Moody’s has announced downward sector outlook revisions to most industries.

As the rating agencies evaluate the overall impact of COVID-19 on issuers’ credit quality, they will be focused on liquidity, the levers that can be pulled to preserve cash (i.e., reducing capital & operating expenditures and shareholder distributions) and the impact that supply and demand has on profitability.

Will There be Major Fallout in Consumer Spending?

Overall, yes, but it is too soon to tell how severe the impact will be.

February 2020 became the final month of the 11-year bull market run, and saw a near-record high for consumer sentiment, largely attributable to low unemployment and pervasive wage growth. According to the U.S. Consumer Sentiment Index the February reading was 101, just shy of the all-time high of 101.4 recorded in March 2018.

Then came March 2020 and, with it, a recorded reading of 95.9. This approximately 5% decline was driven by pandemic fears and extreme market volatility. While significant, this drop is substantially less than the 13.6% decrease during the financial crisis. Additionally, these conditions also led to a decrease in consumer-spending contribution to GDP from 2.6% to 2.0%, the lowest recorded contribution since 2013.

Consumers could still view these events as short-term in nature and might not expect longer-term economic impacts. But declining consumer confidence could have material impact on the overall economy, because 70% of U.S. GDP is tied to consumer spending. To help alleviate the severe consequences of retracting consumers, and to keep markets liquid, measures such as the Federal Reserve’s emergency rate cuts and low-interest loans for small and mid-size businesses are being deployed.

How Does a Public Health Crisis Impact Financial Filings and M&A?

The Securities and Exchange Commission (SEC) has longstanding guidance that risk factors may need to be updated before a filing deadline, particularly in the case of a rapidly evolving issue that involves material uncertainty. In light of COVID-19 there has been an uptick in the filing of material events reports (on Forms 8-K or 6-K).

In response to COVID-19, the SEC has made two announcements providing relief to SEC registrants. The first was on March 4th, and the second was on March 25th. According to the March 25th directive, companies can receive a 45-day filing extension for deadlines between March 1 - July 1, 2020. However, it will only be granted if they can assert that the delay is due to COVID-19; they must also include company-specific risk factor(s) explaining the impact, if material, of COVID-19 on its business. Companies that are not planning to seek an extension should still consider whether an unscheduled 8-K or 6-K is warranted.

The effect of COVID-19 on signed M&A transactions has yet to be fully determined, as buyers continue to evaluate whether the event will have a significant long-term effect on the target company. However, COVID-19 has prompted buyers and sellers to rapidly adjust contracts for events like a public health crisis. In fact, new material adverse effect clauses are now specifically including pandemics and/or other public health emergencies.

The Corporate Finance Advisory team examines themes or trends that serve as a source of thought-leadership for management teams. Areas we cover traditionally include corporate strategy and M&A, capital markets, capital structure/allocation, market intelligence, or other accounting and regulatory subject matter.

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