FROM AN ESG PERSPECTIVE, HOW HAVE GOVERNMENT POLICY RESPONSES TO THE PANDEMIC IMPACTED CREDIT MARKETS?

Governance is often considered the most material ESG pillar of sovereign and corporate credit analysis. It drives all other aspects of the management of a country or corporation, including environmental and social factors. Adapting to the COVID-19 crisis has been a test of governance for countries and corporations. While some countries have fiscal and monetary ability to offer support, the degree and pace of initiatives has varied across the globe.

Since the pandemic began, liquidity and capital structure needs have been the most prominent corporate governance issues, and Loomis Sayles credit analysts are watching for signs of stress in the companies they cover. As companies grapple with the fallout from widespread lockdowns, covenants, which detail critical protections for credit investors, will be an ongoing area to monitor. A small number of issuers have proposed adding lost earnings back to EBITDA due to COVID-19, which many investors are treating with skepticism. The methodology for determining the lost earnings is unclear, but if this type of adjustment becomes standard in the market, it could cause significant discrepancies in the covenants and raise concerns about the relevance and comparability of the EBITDA-based covenant provisions and potentially management credibility.

There is also speculation in the credit markets that the COVID-19 crisis may complicate contract enforcement, and Loomis Sayles’ credit analysts are monitoring this issue. Some companies believe the pandemic is a force majeure event, which allows certain contracts to be terminated. For example, material adverse change clauses are often part of merger and acquisition (M&A) deals to protect the buyer of a business when the M&A target is negatively impacted by the economy or a catastrophic event. COVID-19 could make these clauses an issue for outstanding deals. We have also seen that most business interruption (BI) insurance excludes losses from pandemics or new viruses. Insurance companies expect increased litigation over disputed BI insurance, as business owners (restaurants, for example) sue for lost income due to government lockdown orders.

HOW ARE MATERIAL SOCIAL FACTORS FROM THE PANDEMIC IMPACTING ISSUERS?

Governments across the world have responded in varying degrees to the pandemic through mandated shutdowns, social distancing requirements, and support for workers and businesses. These measures are having an adverse fiscal impact on governments’ balance sheets and debt profiles.

As companies have reported first-quarter earnings, Loomis Sayles credit analysts have started to see initial guidance related to the COVID-19 crisis, and how material social factors are impacting corporate and sovereign bonds. Social distancing requirements have resulted in some industries facing dire near-term sales forecasts, including most brick-and-mortar retailers, restaurants, airlines, theme parks, casinos, energy-related businesses, automotive manufacturers and hotels. While layoffs and furloughs within these industries are ballooning, many companies have pledged to protect employees by avoiding layoffs for the duration of the crisis. Others are announcing furloughs instead of layoffs, which can be preferable from a social perspective because they are generally temporary and may include critical benefits such as healthcare.

The higher education sector is also under pressure, given the need to offer pro-rated refunds on housing and dining fees, and discounted tuition in some cases, when students transitioned to online classes. Meanwhile, volatile capital markets have pressured endowments and investment earnings, an important source of revenue. The question of whether college campuses will reopen in the fall is a major overhang for the sector. The future of small colleges with limited endowments looks even more challenging.

There are some bright spots, notably the banking sector. A number of social initiatives have been implemented in an effort to ensure retail and corporate customers have access to the financial system. Banks have continued to operate well, even under stay-at-home mandates. Banks are being encouraged by their regulators to extend loan terms and offer flexibility to customers adversely affected by the pandemic. One major automaker's finance arm, for example, noted that approximately 10% of its loan customers are taking advantage of payment forbearance programs for current customers.

HOW IS THE PANDEMIC IMPACTING ENVIRONMENTAL FACTORS?

The human suffering related to COVID-19 cannot be overstated. However, there are some potentially positive environmental results from the crisis, with increasing evidence that the economic slowdown is contributing to a drop in pollution and greenhouse gas emissions. The Principles for Responsible Investment (PRI) has written that the stimulus required to spur economic growth after the virus should target green projects to both stimulate and decarbonize the economy. Also, some of our reliance on carbon-emitting sectors may permanently decrease as a result of shifting behaviors.

Consistent with the PRI guidance near term, Loomis Sayles fixed income research analysts have focused on assessing the global sovereign government efforts to stabilize their economies, and the health and liquidity of the corporate credit markets. Once companies and countries have moved past this very turbulent initial pandemic period, our fixed income analysts will focus on the longer-term social and environmental impact of the crisis on our investments, and on the market, the workforce, and the communities where they operate.