arrow_back Capital Edition

Share on Twitter
Share on Linkedin
Share on Facebook
Edition 9 - PEOPLE

Running a credit desk through the crisis of a generation

Sonia Baillie has been through a few crises in her 23-year career as a fixed income specialist. But the head of credit at AMP Capital hasn’t seen one quite like the COVID-19 pandemic. In this Q&A, Sonia recalls 2020 running the credit desk.

What were credit markets like going into the COVID-19 pandemic?

A year ago, credit markets were “late cycle” – bond prices were rising, and yields were falling. Credit spreads had narrowed because investors had been reaching for yield. That, in itself, provided challenges. What would default rates be like in 2020? What was the best way to pick up returns without undue risk?

While there will never be a good time to enter a global pandemic, at least being in late-stage in the credit cycle meant we had already taken action to strengthen the quality of our portfolio, taking more conservative positions and shoring up against risk.

We had moved up the credit quality spectrum and shortened our exposure on the credit curve by increasing our allocation to shorter-dated bonds. We were being more selective about what to buy. Non-investment grade bonds, which can contribute up to 10 per cent of our portfolio, became less attractive as spreads narrowed. The risk wasn’t worth the reward.

Of course, none of us had fully anticipated the speed and severity that a global health crisis was about to embroil financial markets. We learnt very quickly.

By the time the COVID-19 outbreak affected financial markets, we had moved up the quality curve moving away from BBB-rated securities, and most exposures had maturities that were in the three- to five-year range. It held us in good stead for what was to come – a pandemic that shifted markets more abruptly than anything else we had ever experienced before.

How did the 2020 crisis compare to the Global Financial Crisis of 2007-08?

The coronavirus pandemic was initially much more a liquidity event than a credit event. The Global Financial Crisis in 2007-08 was much more of a credit or solvency event. This time around it was liquidity that caused spreads to widen, at least initially. Spreads in the US and Australia shifted faster than ever before, reflecting the shock of the pandemic. Some may argue that the liquidity squeeze reflected and was amplified by structural changes that have manifested from changed market-making dynamics as a result of evolved banking regulations and the huge shift into passive or index investing. It’s fair to say it did feel like a panic event in the face of unprecedented uncertainty at the time.

There wasn’t a lot you could do as spreads gapped. It was that quick. We had some hedges on some of our investments, but they didn’t perform as well as we had wanted. At least we had entered the pandemic in a conservative position.

With credit spreads widening it was a matter of watching and listening very closely to policy makers – the Fed, [Australia’s] Federal Treasury, the Reserve Bank of Australia (RBA), as well as the federal and state governments – to pick up signs of coming fiscal and monetary support. What was different this time was that investors were also trying to decipher what immunologists and health experts were saying. It wasn’t just economics or finance – it was also medicine and science.

That was a big difference during this financial crisis, relative to the Global Financial Crisis or the European sovereign and banking crisis. It was all about health.

Capital -Edition Image Alt

How did regulators and credit markets respond?

Fairly quickly central banks had moved to support markets. By late March, the US Federal Reserve had instituted a corporate bond-buying program. In Australia, the RBA established a Term Funding Facility to support the banks and business lending. Both moves, and others in Europe and Asia, stopped credit spreads from widening and in fact by late March, spreads were again narrowing. By way of example, Australian major banks’ five-year senior paper was trading close to a spread of 200 basis points. When the RBA came out with its funding support package, their spreads dropped back very quickly to 100 basis points and are now trading tighter than pre-pandemic levels at the start of the year.

At the peak of the sell off, subordinated bank credit spreads and some short-dated corporate bonds were at 400 basis points. You could buy into an investment-grade asset and get a yield four per cent higher than a government bond. Since the Global Financial Crisis, that number had mostly been between 100 and 200 basis points.

So, was it worth investing in credit markets?

During the period – March, April and May – investing was possible, but you needed to have conviction in your cash flow analysis and the quality of the balance sheet of the bank or corporate you were investing in. And we were focused on buying short-dated where the liquidity premia was very attractive due to the market dynamics at that point. Beyond three years, the visibility of what could happen to the risk profile of the bank or corporate, due to COVID-19, wasn’t always very clear. It was a time in the cycle where active credit managers earned their money, and rewarded fundamental investors.

Undoubtedly it was challenging. Sectors impacted by COVID-19 were beaten up and experiencing a spike in global default rates – lodging, transport and gaming, for example – those that were directly impacted by lockdowns. Retailers and property groups were also not immune. It became harder to look at what was happening and fully understand their credit profiles and the long-term implications of the pandemic.

Then there were sectors such as energy and the airports. Airports was a sector we knew well. We immediately looked at the ability of operators to turn off both capital and operating expenditure. What could management do in terms of cash flow. We had to retest all our assumptions around passenger numbers for domestic and international travel. It was an incredible period in the bond markets.

What other differences were there this time versus other crises?

Unlike previous financial crises, boards and management were much quicker to respond and raise equity this time around. During the Global Financial Crisis, equity raisings began six months after the event. This year, equity raisings began in April, one month after the pandemic hit financial markets. Management had learnt the lessons of the Global Financial Crisis and the benefit of preserving liquidity and fortressing balance sheets in the face of an uncertain outlook.

The central banks around the world, in particular the US Federal Reserve and the RBA, reacted quicker and did a good job. There will always be trade-offs in terms of cushioning the economy and supporting employment, and that has happened this time. But they kept financial markets running.

At the peak of the sell off, subordinated bank credit spreads and some short-dated corporate bonds were at 400 basis points. You could buy into an investment-grade asset and get a yield four per cent higher than a government bond. Since the Global Financial Crisis, that number had mostly been between 100 and 200 basis points.”

Another important difference this time, compared to the financial crisis, was where leverage sat. In the lead up to the financial crisis in the US, large amounts of debt sat with households. Since then, the build-up of debt in the US has been in governments and corporates as households repaired their balance sheets. In Australia, it’s the other way around. Household debt has grown but the growth of non-financial corporate debt has been slower, especially compared to the US1.

What about the next year?

It really does depend on how the virus plays out, and whether a vaccine is discovered and when it can be effectively rolled out around the globe. That is the biggest unknown for investors. In the meantime, the outcome of the US election will be a focus for the markets. So too will be how second and third waves of COVID-19, particularly in Europe play out. And of course, there’s always third quarter reporting season for investors to digest.

Investors also need to look beyond COVID-19. Many of the structural shifts and trends in industries were happening well before the pandemic hit. In many cases, COVID-19 has just accelerated those trends.

It has been an incredible year and the truism has never been so relevant – where you invest really matters.  


1 Based on global debt aggregates, published by BIS

Important Notes

While every care has been taken in the preparation of these articles, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in them including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. Performance goals are merely goals. There is no guarantee that the strategy will achieve that level of performance. The information in this document contains statements that are the author’s beliefs and/or opinions. Any beliefs and/or opinions shared are as at the date shown and are subject to change without notice. These articles have been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. They should not be construed as investment advice or investment recommendations. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Click for previous article
Economics and markets
What our economists learnt in 2020
AMP Capital
Click for next article
Sustainable investing
Undoing the dark realities of tobacco
Adam Kirkman

Cookies & Tracking on our website.  We use basic cookies to help remember selections you make on the website and to make the site work. We also use non-essential cookies, website tracking as well as analytics - so we can amongst other things, show which of our products and services may be relevant for you, and tailor marketing (if you have agreed to this). More details about our use of cookies and website analytics can be found here
You can turn off cookie collection and/or website tracking by updating your cookies & tracking preferences in your browser settings.