- Brainyard listened in on speakers including IMF managing director Kristalina Georgieva, EY CIO Carmine Di Sibio and Softbank CEO Rejeev Misra.
- Key themes include the pandemic-driven acceleration of trends in tech, real estate and retail and new opportunities presented by broader adoption of technology.
- The biggest potential collateral damage? Complacency.
Kristalina Georgieva, managing director of the International Monetary Fund, kicked off the Milken Institute’s virtual Summer Series 2020 with a message to the think tank’s audience: “We cannot overcome this crisis unless we come together.”
For Georgieva and the IMF, that means unifying 189 governments with private-sector and healthcare entities to rebuild the global economy post-COVID-19. The fund has implemented a “very accelerated process of decision-making that is tuned to the speed of response necessary,” she said. As a result, in seven weeks during the height of the crisis, 70 countries received financial support from the fund’s $1 trillion in lending capacity, in cooperation with the World Bank and the European Commission. More may be forthcoming.
Despite those efforts, Georgieva sees risks: Of an extended U-shaped recovery, a concern echoed throughout the conference. That measures taken to put a floor under the economy are driving record government debt, even as liquidity in private markets raises asset valuation and risk appetite. That any new shock, including a second wave or a rash of credit defaults, could dramatically stall momentum, particularly in developing economies.
“We are not out of the woods yet,” she said.
Offsetting those risks is what Georgieva considers an effective global monetary policy response to the pandemic.
“I have never seen such a strong, massive, phenomenal action,” she said. “On the fiscal side, we are coming close to $11 trillion of fiscal measures to put a floor under the economy. If that didn’t happen, we would have had massive bankruptcies and possibly structural unemployment for a long time to come.”
For CFOs, Georgieva’s call to action is to tackle inequality, especially inequality of opportunities. Use digital advancements to create more even and sustainable growth, and address the climate crisis by taking advantage of incentives for low-carbon, climate-resilient and environmentally sustainable growth.
“The biggest collateral damage would be if we sleep through a huge opportunity to shift gears in our economies, and our societies, for the better,” said Georgieva.
Insight: Equity markets are fully priced and embracing a “V-shaped” economic recovery — but the debt markets are skeptical.
The second part of the opening plenary for the Milken Summer Series saw several investment and financial advisory leaders discussing the state of the capital markets in light of the coronavirus pandemic. Steve Tananbaum, founder, managing partner and chief investment officer of GoldenTree Asset Management, paraphrased the state of the capital markets as “A Tale of Two Cities.”
A variety of measures would suggest that the equity markets are pretty fully priced and are confident in somewhat of a “V” economic recovery. However, the debt markets seem a bit more skeptical because, while money may look cheaper, loans made today are significantly riskier than those made pre-pandemic.
Credit is Cheap to Equities
Valuations have diverged significantly, with credit generally down in the 1st quartile while equity is generally 4th quartile
|Market Barometer Across Asset Classes|
|LTM P/E||Price/Book||LTM P/E||U.S. High Yield||EU High Yield||U.S. Loan||EU Loan|
|June 12, 2020||21.5||3.5x||16.7||607||533||671||674|
Source: Milken Institute
Looking back on the 2008 recession, Tananbaum highlighted key differences between triggers and results:
|2008/2009 vs. 2020/2021|
|Recession Trigger:||Financial Crisis||COVID-19 Crisis|
|Economic||Max contraction in U.S. QoQ GDP annualized||-8.40%||-30% to -35%|
|Peak unemployment||10%||15% to 20%|
|U.S. GDP recovery time||18 months||18 to 36 months|
|Government||Main recipient of federal support||Banks||Individuals|
|U.S. fiscal deficit||-13%||-25%|
|Central bank activity||New||Proven & expanded|
|Increase in fed balance sheet as % of GDP||9%||16%|
|Market||Peak HY spreads||2147 bps||1087 bps|
|Time which HY spreads wider than 800 bps||11 months||3 weeks|
|Low LTM P/E of equities||9.8x||13.8x|
Source: Milken Institute
Scott Minerd, global chief investment officer of Guggenheim Partners, agrees with Tananbaum and points out another difference.
“The tone of the conversation has changed a great deal,” said Minerd. “In my experience, back in 2008 through 2010, the government was very wary of private-sector involvement. They were suspicious of all ulterior motives, and so on and so forth. Today, they’re very anxious to hear ideas, and they’re very supportive.”
Minerd also noted a faster response from the government compared with the previous recession.
Insight: Considering going private? Now might be the time.
From the perspective of Lara Warner, chief risk officer at Credit Suisse, the turbulent times presented by COVID-19 also bring opportunities to invest.
“Many of our clients are actually looking to take advantage,” said Warner. “And I do think that if you’re in a weaker environment, you’re looking to stabilize your balance sheet. If you’re in a position of strength, you’re looking to take advantage of your position.”
That could mean a major wave of restructuring and recapitalization as well as an increased interest in going private, given some of today’s valuations.
Warner also sees social contracts being rewritten between employees and employers, clients and advisers and, on a larger level, between banks, governments and economies. That could recast how we operate going forward.
“I think it’s such a unique time to reestablish not only how we invest but to re-establish the trust, and the global collaboration, that I think had completely broken down, not only with the financial institutions, but also with governments,” said Warner. “We really are at a tipping point where the financial markets can make an incredible difference if we choose to, in which direction the world goes, and that’s certainly how we’re thinking about it at Credit Suisse.”
Insight: Seed financial, technological and mentoring ‘deserts’ to help drive equality.
The first day of the series brought a conversation between Institute chairman Michael Milken and Robert Smith, the founder, chairman and CEO of Vista Equity Partners. If Smith’s name sounds familiar to you, that may be because he made headlines last year after announcing he would pay off the student loans of roughly 400 graduating seniors at Morehouse College.
Their chosen topic, equality and equity, was especially relevant due to the issues highlighted by both the COVID-19 pandemic and protests for racial justice. In the discussion, Smith identified three areas in need of attention to address systemic inequality: Finance, technology and mentorship.
Just as there are food deserts, there are also financial deserts — and the statistics are startling: 70% of African-American communities don’t have bank branches in their neighborhoods, and 41% of U.S. African-American-owned companies have closed since the start of the pandemic. Looking at the small-to-midsize sector, 90% of African-American businesses are sole proprietorships with four or fewer employees, and these firms make up 60-plus percent of the employment base in their communities.
Many African-Americans lack lending relationships and access to capital. The small banks that are present in some of these communities, like community development financial institutions (CDFIs), minority depository institutions (MDIs) and credit unions, have approximately $5 billion in assets versus the $20 trillion possessed by the overall banking infrastructure.
Yet, according to Smith, when several large African-American businesses went to large banks for PPP loans under the CARES Act, they didn’t hear back. When those requests were shifted over to a CDFI or MDI, they were processed.
To help disadvantaged communities restore, repair and regenerate economic opportunities, Smith is encouraging financial service providers to drive capital into these deserts. By his estimate, an influx of $300 billion over 10 years would give an annual GDP uplift of $1.5 trillion.
However, technology is needed in addition to capital.
“I think the real answer is to enable these small banks, the CDFIs, these capillary banking infrastructures, to actually be more robust — you need to modernize the infrastructure of these banks to drive true capital on the order of tens, if not hundreds, of billions of dollars over time into these communities,” said Smith. “It can be done today leveraging technology that’s available. We just need to figure out efficient mechanisms to drive not just Tier 1 capital, but lending capacity and secondary loan capacity to help those banks run more efficiently and drive the capital into these small businesses.”
The need for technology doesn’t just apply to the banks, though. Communities and local businesses must also be digitally enabled. Many urban areas, for example — so-called digital deserts — lack access to broadband services. Particularly when populations are forced to shelter at home, that lack becomes even more dire for businesses and educational systems. Smith called on tech providers to bring services and training to underserved communities.
The last area, mentorship, holds particular relevance in light of 2020 graduates entering the job market.
Insight: Now is the time to go all-in on your internship program.
“I was a little disturbed weeks ago when I heard a number of our young people saying that their internships were being canceled,” said Smith. “This is the exact wrong time to do that.”
In fact, he says smart companies will go even bigger.
“I think one of the most important things that any executive can do today is figure out how many interns you have and frankly double, triple or quadruple that number,” said Smith. “Expand your mentoring capacity virtually because ... it’s better that they’re engaged and thinking about business opportunities and access to the American Dream, than being idle at home. This is probably one of the most important things for executives to do — and do it in a way that it enhances your ability to manage diversity in advance.”
To facilitate those connections, Smith and his team built InternX. The platform is designed to help companies onboard interns, particularly those from the African American, Latinx and female STEM populations. It now has 170 business partners, including companies like AIG, Cisco and Dell, and 12,000 students in the pipeline. The InternX team also built 640 modules and a handbook to help companies manage virtual internships effectively.
Insight: The airline, education and entertainment industries will look much different in the post-COVID world.
When it comes to COVID-19, Ed Bastian, Casey Wasserman and Janet Napolitano — CEO of Delta Airlines, chairman of LA 2028 and president of the University of California, respectively — have experienced uniquely overarching effects on their respective organizations. Yet, with those experiences come industry-agnostic lessons on moving forward and learning to reopen amid uncertainty.
Delta’s Bastian sees air travel as a bellwether for the economy.
“It’s starting to recover,” he said. “We bottomed out somewhere in the middle of April. Under all the stay-at-home restrictions, we were down to probably only about 5% of our average traffic. Since that time, we’ve tripled in size — we’re up to 15%.”
The demographic traveling now, said Bastian, tends to be younger people seeking adventure and taking advantage of bargain deals, although that may shift as traditional destinations like Disney World and casinos begin to reopen.
However, he still sees travel remaining leisure-orientated as opposed to business and expects to fill about 50% of seats by Labor Day.
After that, growth depends on comfort level.
“That will be another important milestone for us because typically business travel picks up again after Labor Day,” said Bastian. “But I think, candidly, this is about a three-year recovery.”
When it comes to the future of air travel, Bastian references how deeply the procedures around flights changed after 9/11 and the resulting implementation of the TSA. Delta has asked that TSA play a role in coronavirus safety measures, including incorporating temperature checks into the passenger screening process. In the meantime, Delta and many other airlines have been barring people from boarding without masks.
“We have to take [mask-wearing] very seriously, just like someone not wearing their seatbelt or standing while the plane is taxiing,” said Bastian. “Masks, for the next 12 months or longer, are going to be one of those protocols that we’re going to have to get used to.”
Despite the struggles experienced by dramatically decreased demand for air travel, Bastian does see some silver linings for the industry, including the chance to accelerate the investment in infrastructure, sustainability and technology while airport volume is low.
Insight: It’s time to permanently rethink business travel policies.
He also sees potential for a re-envisioning of business travel, citing in particular people taking overnight trips across the country or to Europe for a one-day meeting and then turning around and flying back.
“They’re very inefficient and unproductive,” said Bastian. “Our business should not be built on that type of travel.”
From an education perspective, the University of California expects to return in a hybrid model.
“Wet labs, performing arts, studio arts,” said Napolitano. “Those things where it is really necessary to physically be there, we will be endeavoring to be in person.”
While still awaiting state guidance on living situations for students, Napolitano doubts there will be triples in dorms. And like Bastian, she expects people to mask up.
“It’s a matter of public safety and public health,” she said. “It’s a responsibility not just to themselves but to members of the community, and I think that’s the way we need to approach it.”
As with air travel, measures necessitated by the virus could also render some benefits. Discovering new ways to use technology for learning, for example, will allow for the University to expand capacity. As demand increases in the next several years for large, public universities to return to a full population, there will likely be more classes offered in both online and in-person formats.
“I think the core educational, residential college experience at a place like the University of California will come back bigger and better,” said Napolitano.
As a sports and entertainment executive, Wasserman had an optimistic view of the near future as consumers return to their favorite pastimes.
“Once there is a vaccine and it is widely available, I think you’re going to see our business return fairly substantially,” said Wasserman. “I’d say maybe 80% in the next two years.” He expects that it will take into 2022 until large live events, including concerts, Broadway shows and sports, fully recover.
And, that “new normal” may look slightly different.
“There will be some changes,” said Wasserman. “Sporting events will operate a little differently. You probably won’t see a lot of cash transactions. You’ll probably see a lot more grab-and-goes for concessions. You’ll see different architecture around bathrooms and different cleaning protocols.”
Wasserman stresses the need for nuance — fully understanding the complexities and behaviors around certain events prior to reopening. For instance, an outdoor sports stadium, where physical distancing can be instituted, may need a lighter hand than an indoor concert. But even then, leaders must plan for previously unproblematic situations, like how to avoid everyone going to the bathroom during halftime.
In the end, Wasserman brought it back full-circle to the airline industry.
“It is probably one of the best places we can learn from on how information can be used to open things up without a medical solution,” he said.
Insight: For investment firms, the 2020 recession — and how to handle it — is different from its 2008 predecessor.
How do some of the biggest investment firms in the world handle a pandemic? And how does the current crisis compare with the Great Recession?
Tom Finke, chairman and CEO of Barings; Penny Pennington, managing partner of Edward Jones, and Emmanuel Roman, PIMCO’s CEO and managing director, all joined the Milken Summer Series to give their takes.
“The markets weren’t front and center this time,” said Pennington. “It was fascinating to us that as the markets were selling off by 35% and 40%, our clients were asking us to counsel them first on their physical health. Then on their emotional wellbeing. And thirdly, on their financial resilience. So, listening to each individual client about the things that they were newly concerned about, we talked about human-centered, complete wealth management for our clients. What we believe is more true than has ever been before, is the power of human relationships.”
To start, then, the current economic slowdown is more multifaceted than its predecessor.
“We’re galvanized in a different way than we have been before — this is a triple pandemic, isn’t it?” said Pennington. “It’s a health pandemic. And that has manifested into an economic pandemic. And that has catalyzed racial and social unrest like we haven’t seen in a long time.”
For their own firms, companies that got rid of individual offices and cubes are now busy reassessing real estate needs.
“We, for years, have opened up and done away with the offices and leaned into the trends — more engagement and people sitting side-by-side,” said Finke. “I don’t know if we’ll need half as much space or twice as much space. That ties into the fact that I do think there are some roles that will more permanently have the opportunity to work from home.”
Looking forward, Finke expressed some hesitancy on the potential rate of economic recovery.
“If you look at where we were in March and then you, in March, said, ‘Where will the stock market be at the end of June?’ I don’t think many of us would have written this scenario,” he said. “We do expect to be in a mode of a very severe credit cycle for a period of time. We do think that there are investable ideas and companies that are coming out on the better end of this. But there’s going to be continued pain in the markets, especially the credit markets.”
Insight: As China recovers, a key focus will be retaining its status as a manufacturing leader.
As the first major economy to lock down, China is also one of the first to take steps toward economic recovery, providing what could be a useful blueprint.
Eric Chen, managing partner of the Softbank Vision Fund, says he’s seen three stages among Softbank’s portfolio companies:
- The emergency reaction: A health-oriented focus on keeping their partners and employees safe.
- The stabilization phase: Analyzing the situation, trying to figure out where the business is and what the recovery trajectory is likely going to be.
- The recovery stage: Thinking and acting on long-term plans around how the business will play a role in the future business environment.
Right now, both Chen and Jane Jie Sun, CEO of Trip.com, consider China’s business environment to be in the recovery stage, with businesses seeing recovery percentages of 50% to 100%, depending on the industry.
Jianguang Shen, VP and chief economist of technology, marketing and financial advisory firm JD Digits, said he expects overall economic recovery in China to be “V” shaped, though that is once again dependent on industry, with some of the slower recoveries, like of travel firms, causing the right side of the “V” to be lower than the left.
And, Chen sees businesses that depend on global exports and supply chains facing more challenges.
“We came to the realization that, given the different culture and different government systems and different [approaches on how] to fight the virus, the trajectory of containment is going to be very different around the world,” said Chen. “So as we open the global economy and global trade, you are going to see a very uneven approach.”
Building a more robust and agile supply chain may prove difficult as well. While many companies have discussed moving manufacturing out of China in light of the COVID-19 disruption, Chen doesn’t necessarily see that as materializing.
“I think this topic of moving manufacturing out of China has been discussed before and has been tried,” he said. “I think the effectiveness of that has been quite questionable, just because the base of manufacturing [in China] is so large and powerful, the workforce is well trained to work hard and the quality of the workforce is very good. The ecosystem is rich, particularly when it comes to low-end manufacturing and also even electronics manufacturing.”
The country’s workforce is set to increase in size, he said, as 8 million students graduate and enter the workforce this year. While the recovery pace isn’t quite fast enough to accommodate all graduates, Chen said China’s government has created more civil service jobs and expanded graduate programs to help fill the gap.
However, many steps China is taking won’t fly elsewhere. For example, the Chinese government contained the virus by assigning all its citizens a “health code” that assesses risk by pulling together data on the individual’s travel, medical history and other factors. This level of control and tracking is ubiquitous in China, to the point that it affects every aspect of life — and raises data privacy concerns that would derail such methods in other parts of the world.
In a more fiscally oriented example, both Chen and Shen note that the Chinese economy is organized such that the government can not only inject liquidity into the banking systems and lower interest rates, it can also order banks to lend a certain amount to small-to-midsize companies.
In addition, the Chinese government has encouraged infrastructure investment to support the digital economy, paving the way for companies to invest in technology and software.
Insight: Don’t expect a V-shaped recovery in the U.S. But it doesn’t need to be an L, either.
“I think there was a belief at the beginning of this that somehow, magically, we go into a V-shape recovery, partly because the economy was so strong coming out of January and February,” said David Hunt, CEO of PGIM, the asset management arm of Prudential Financial, in a session on restarting the economic engine. “We are going to need to adjust our expectations. And that has huge ripple effects.”
Just this week, New York City said it would need to cut 22,000 civil service jobs to save $1 billion because of reduced tax revenues.
In fact, Hunt said PGIM sees full recovery taking a couple of years. But that doesn’t have to mean a bad choice of rolling shutdowns versus hospitalizations and deaths.
“Japan has actually handled this remarkably well, because individuals comply,” he said. “They’ve always worn masks, they continue to do that, they comply with the social distancing rules. Our problem here, I think, is that we have been too reliant on an overly prescriptive set of policies and not reliant enough on a belief that actually this is about individuals choosing correctly.”
Charles Scharf, CEO of Wells Fargo, concurred: “You follow a set of rules, with social distancing, with masks, and those things are extraordinarily effective compared to just acting like the world is back to normal. The world is not back to normal. It’s going to be quite some time until we get back to normal. But we have to continue to move forward so that we can get people back to work.”
As to how that happens, Scharf says that banks are working to disperse funds in a smart way, with over 50% of the money that Wells Fargo has deployed going out in loans of less than $25,000. Over 80% are to small businesses with fewer than 10 employees.
“We had something like $80 billion worth of additional credit advanced in the month of March alone,” he said.
Bigger picture, government efforts have been arguably less effective.
Hunt pointed out that one of the great lessons from the global financial crisis was that if you rely solely on the Fed, you may stabilize and ultimately heal markets. But you won’t protect the “real” economy or Main Street.
“I desperately, desperately want to make sure that we do not make that mistake again,” he said. “And so while I’m very happy with what we’ve been able to do at the Fed, and I think they’ve been bold and broad in their thinking, I’m really concerned that we have not done enough to get money into the hands of small businesses, and to some extent into direct payments for those that really, really need them.”
Insight: Private-sector financial executives are pushing for a second round of stimulus. The Fed may listen, so keep an eye out for new opportunities.
Hunt is a proponent of going beyond a second PPP round for small businesses.
“I mentioned the need for significant dollars to be spent for cities and municipalities,” he said. “And we know that as a country, one of the ways to restart our economy is through the productivity that we get from infrastructure investment. I don’t just mean bridges and tunnels. I mean our entire power grid, I mean broadband to the home.”
That’s expensive, and he insists that we’ll need to double the $2 trillion in fiscal stimulus already put forth. And while we’re at it, get much more efficient in dispersing funds.
“If there’s ever been an argument for fintech, it’s the fact that we paid $10 billion to give $350 billion away,” said Todd Boehly, cofounder and CEO of private investment firm Eldridge Industries.
Other pickups from the session: New regulation may arise from the pandemic response, much as Dodd Frank followed the Great Recession. What might that look like? Regulatory limits on the amount of leverage companies can take, the amount of inventory that they have to maintain and the kinds of supply chains that they have, so that none of those three areas are as vulnerable as they clearly were for many companies going into this crisis.
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“I also think that you’re seeing an evolution where landlords are becoming land partners,” said Boehly. “The real estate owners who are thinking about how to be more collaborative with tenants are going to be the ones that succeed.”
As an example, leases may have provisions where if a tenant’s revenue stops, it has the ability to defer payments under the contract terms.
Insight: Forget the crystal ball. When investing, think about being in the “risk-mitigation business.”
His Excellency Waleed Al Mokarrab Al Muhairi, deputy group CEO and CEO of alternative investments & infrastructure at UAE investment firm Mubadala, joined the conference to discuss investment strategies tailored to the new normal.
The good news? Uncertainty doesn’t mean investments are stopping.
“You’ve got to have conviction that the risk and reward are in balance,” said Al Muhairi. “Because that’s ultimately how we think about every investment that we make. So when we try to measure risk during these uncertain times ... the new normal adds another premium to that and another level of uncertainty.”
Today, figuring out whether return is going to be commensurate with risk in “the new normal” involves an even larger amount of time trying to figure out what could go wrong.
“So at the end of the day, it just adds another variable to the way that we try to model out risk,” said Al Muhairi.
For the Mubadala fund, one focus is on emerging technologies: “The nexus of artificial intelligence in healthcare and biotech,” is presenting tremendous opportunities, he said. As people avoid hospitals, teleconsultations and stay-at-home medicine will be the next great trend.
“I’m not in the prediction business,” said Al Muhairi. “I’m in the risk-mitigation business. And what that means is, if I can find an opportunity that’s going to be robust, even under difficult circumstances, I’m going to want to put capital there. And that’s how we try to navigate this time.”
Insight: The coronavirus has accelerated trends that will reshape how we approach commercial real estate, retail and living situations.
The consensus was clear: Real estate — in the scope of living, retail and other commercial properties — is forever changed. The coronavirus pandemic has exponentially accelerated trends previously in motion.
“I view what has happened as an acceleration — we had too much retail space before, especially in the United States,” said Richard Mack, co-founder of Mack Real Estate Group. “We had too much hotel, and we probably still have too much hotel. We had too much office. This oversupply is in part because of the changing demands created by technology and the changing patterns of living. All these things had been disrupting real estate, but the pace has been really slow … now they are going to happen faster.”
However, Mack cautions against over-adjusting, particularly when it comes to investments.
“The markets are telling you that office space is never coming back. Well, I don’t necessarily agree with that,” said Mack. “[They’re telling you] that telecommunications, data centers and cell towers are really the only place to invest. And so the stock market is overreacting to the acceleration of these trends. But yet, in the private sector, we don’t see assets trading at a big discount yet.”
In fact, the theme of acceleration was strong in the conversation, with Joseph Sitt, chairman of Thor Equities, calling this period, “The Great Acceleration 1.0.”
“In every single sector of the economy, you would see the most dramatic acceleration of all the disruptors we saw happening before, now effectively moving pace and schedule from five to 10 years from today to only one to two years from today,” he said. Specifically, Sitt cited migrations to cloud kitchens, e-commerce, green tech, cloud computing, streaming, and — a shift near and dear to many quarantined hearts — from fashion to athleisure.
When it comes to the transition from brick-and-mortar retail to e-commerce, Mack asserts the overhaul is overdue.
“I think that retail as a business, and as part of the real estate business, needs to be fundamentally restructured,” he said. “We have too many retailers on life support.”
He makes the argument that buying out faltering brands, like J.C. Penney or Neiman Marcus, is a bad idea.
“I just think it continues to delay a problem that we need to face,” he said. “If things are going to accelerate, we need fewer retailers, we need fewer malls, we need better retailers, we need better malls and we need better delivery systems and competition for Amazon.”
There’s a political tilt to some of the trends as well. Mack noted that as political divides deepen, businesses are investing and moving HQs to “red states and cities” to take advantage of lower taxes what they consider a more pro-business attitude.
“People are afraid in New York, Chicago, all the markets that have built up a big deficit spending and have bigger taxes,” he said, citing growth in Tennessee, Texas and Florida.
The real estate shift is not limited to commercial, either. Residential will likely feel the impact as well.
“Gateway cities have been the best places to invest, historically, but part of what we are seeing from this acceleration of trends is the rise of some suburban attachments to gateway cities,” said Mack. “This is part of the red state, blue state [trend, as well as] telecommunications. This is millennials who want to stay in cities but be in smaller cities as opposed to being in suburbs. ...We’re going to see the rise of other nodes of urbanization.”
Insight: The credit market is in better shape than you might think ...
There’s a lot of talk about the difference between Wall Street and Main Street, and credit markets are arguably the area of maximum divergence.
“In the decade prior to COVID, there was an explosion of mismatched capital structures on the buy side,” said Joshua Friedman, co-founder, co-chairman and co-CEO of Canyon Partners LLC, pointing to mismatches in yield, record-levels of debt to EBITDA and sidestepping of oversight.
“For the first time in the history of high yield, over half the bonds that were issued were issued in the private markets, as opposed to the public markets, which is a way of avoiding the kind of controls that the public markets provide,” said Friedman. “So you saw a lot of these excesses taking place, with 85% or so of bank debt being covenant light — which really meant covenant free.”
Still, George Hicks, co-founder and co-CEO, Värde Partners, pointed out that parts of the credit markets are in good shape, at least on the note-issuance side.
“If you look at investment-grade credit in the U.S., new issue of a trillion,” said Hicks. “A couple weeks ago was the biggest week ever for new high-yield issuance.”
While credit spreads have narrowed, parts of the market are pretty robust. Whether they’ll stay that way depends on the length and depth of the downturn and continued actions by the Federal Reserve.
“Recessions have consequences for credit markets, and parts of that are being masked by the Fed,” said Hicks. “Whenever you have a recession, ultimately, you’re going to see defaults go up about 10% ... there are going to be some challenges ahead for us. And there’s often a delay between the time when you have the economic downturn and when the stuff hits the fan.”
Whether the Fed’s actions can stave off significant defaults remains to be seen; many investors are hopeful. Friedman, however, points out that there are things the Fed can do, and things it can’t do.
“They can absolutely restore liquidity to credit markets, but liquidity is not solvency,” he said. “The Fed can restore confidence to where the capital markets can function, when they literally are frozen and not functioning. That’s great. But they can’t fix over-leveraged balance sheets. That’s a whole other discipline that’s not in their mandate.”
Another issue is that the CARES Act is set to sunset.
“The first leg of this recession … was driven by the supply shock,” said Rishi Kapoor, co-CEO of Investcorp. “However, when consumers stop spending, then you see the second leg of the recession, and that second leg is demand.”
That’s a lot more concerning.
“How do you create employment when you’re already at zero interest rates and business models are facing a solvency threat?” said Kapoor. “On the private side, we believe that this is the time for us to be providing the shovels to the gold diggers.”
Insight: ... but don’t bet on PE funding.
If you’re in the logistics, warehousing or distribution space — shovel providers, in other words — you’re in a better position to access credit than an ecommerce company. And, Kapoor suggests that equity firms will continue to double down on successful parts of their portfolios.
Friedman added that PE firms are in triage mode, making a PE investor a “maybe” at best as a source of new credit.
“I guarantee you that the partners of the private equity firms, when they were looking at a lot of these detailed deals that they’ve done in the last five years, did not say to the vice presidents and the analysts, ‘Please do a pro forma spreadsheet that includes zero revenue for this company for the next three months, followed by quite a hell of a recession after that,” he said.
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Ultimately, the consensus is that once we get past the pandemic, credit markets may well be healthier thanks to precautions — and potentially, as mentioned, new regulations — that will likely be put in place to backstop the next pandemic. But there will be long-term impacts.
“We’re going to have built up the Fed’s balance sheets,” said Hicks. “We’re going to have to pay for that somehow.”
Other predictions: More pushback on globalization and the free movement of capital. Potentially a baked-in expectation that the Feds will backstop credit markets, leading to additional risk taking. And, panelists expect to see continued low interest rates as a result of political pressures.
“Margaret Thatcher used to say how there are only a couple of sources for solving this problem: We can tax people or we can use our savings,” said Friedman. “That doesn’t appear to be the case any longer.”
Insight: Now, every company really is a tech company — or, should be.
“All the technology trends that were happening before? COVID-19 has just expedited everything,” said Di Sibio. “There’s more and more transformation going on. Companies that have been able to withstand COVID are moving very quickly in terms of their digital transformations.”
An area of particular importance? Supply chains.
“94% of Fortune 1000 companies have had their supply chains disrupted,” said Di Sibio. “And a lot of that has to do with using technology within their supply chain, so we’re moving along there. The longer-term, to me, all has to do with being much more technology-savvy.”
Insight: Customers want ecommerce and contactless payments, and Visa is looking to help.
Kelly says that also goes for the small businesses Visa works with.
“[Visa] announced a commitment that, over the next three years, we’re going to digitally enable 50 million small businesses around the world,” said Kelly. “We want to make sure that we help them have more of an online option, because some businesses went into this COVID lockdown and only had a face-to-face model and therefore they were truly shut down. Small businesses that had an ecommerce solution were able to keep some of their businesses going.”
As firms of all sizes look toward technological advancements, there is a larger digital move at play: The rise of contactless payments, which we discuss in-depth here.
“The reality is, the U.S. is the furthest behind in the world when it comes to contactless,” said Kelly. “There are dozens of countries where more than 50% of face-to face transactions are contactless.”
By the end of the year, Visa estimates that 300 million Visa credit cards will be enabled for contactless, and over 80% of merchants already have terminals that are able to accept contactless payments.
The ‘back to the office’ generational divide may not break where you expect.
The availability of technology for working virtually had all panelists thinking of the future of real estate.
“Let’s move on from the day and age of all our people sitting in front of us, working a set number of hours in a shift,” said Humpton. “Let’s embrace this new ability to be virtual, network more effectively and accomplish more.”
She says Siemens believes in a hybrid model and wants to preserve its in-office culture. Still, its offices are going to be used differently going forward, more as meeting spaces than “just going to sit in a cubicle,” she said.
Age plays an important factor in evaluating the need for in-person work. According to surveys conducted by EY of its employees, professionals 45 and older are more comfortable working from home than colleagues in their 20s and 30s. Di Sibio attributed this to the fact that older employees have built their careers and networks, whereas younger personnel still need that human interaction to grow professionally.
Time to Reassess Your Retail & Commercial Real Estate Needs?
Big companies including Twitter, Facebook and Morgan Stanley are permanently shifting to more home-based employees. Will smaller firms follow suit? LEARN MORE!
“I do think offices will change,” said Di Sibio. “Offices will be touchdown locations. They’ll be places to meet clients, they’ll be places to do innovation, creativity and brainstorming sessions. They’ll be places to do new employee orientation and those kinds of things, so offices aren’t going away, but I do think they are going to change.”
Even though companies cannot host their new employee orientations and internships in the office yet, Visa, EY and Siemens all chose to continue their internship programs despite the difficulties of being virtual and are committed to offering learning and networking opportunities.
Technology trends are not the only movements being accelerated. Panelists agreed that ESG initiatives were likely to be fast-tracked as a result of coronavirus and racial tensions in the country, with Kelly identifying sustainability and income inequality as the two main focal points.
“Now that we are thinking about the longer-term, we have a chance to build a more purposeful path forward,” said Humpton. “I’m pretty energized by the prospect of how this focus is going to turn on the afterburners for business.”
Insight: Coronavirus has resulted in “an acceleration of an acceleration” in areas like food, finance, education and health care — but could result in the backtracking of globalization.
On the last day of the Milken Summer Series, Softbank CEO Rejeev Misra joined to discuss the acceleration of trends as a result of the coronavirus and their respective implications.
According to Misra, “the acceleration we are seeing is an acceleration of an acceleration.”
In particular, he cites food, finance, education, real estate and healthcare as industries where laggards will be left in the dust.
In the food industry, the entire stack — from supply chain to real estate to delivery — has all changed on a global level. Dark stores and kitchens are proliferating, eliminating the need for expensive real estate, restaurants, storefronts and extra middlemen. Instead, a warehouse can easily stock and deliver.
Meanwhile, the grocery delivery service Instacart now reaches a whopping 85% of households.
From a finance perspective, rapid technological developments and adoption are rendering benefits to both consumers and small businesses. As an example, millions of small businesses could access CARES and PPP loans digitally.
The next generation is going to be more finance-savvy — and savvier in general.
Digitization is also driving another seismic shift: finance becoming more accessible.
Brokerage services, which used to be considered the province of the wealthy, can now be accessed by more of the population — anyone can open a brokerage account online for free. And other finance innovators are constantly coming online: By Misra’s prediction, the rapid spread of fintech will result in credit card fees coming down, accessible credit at much more favorable terms and more financial services being available through these companies for small businesses.
This trend is not reserved for the finance space. As more educational institutions deliver classes virtually, education is becoming more accessible and affordable. Traveling to get to the best university will no longer be necessary, leveling the playing field between the “haves” and “have-nots.”
From a healthcare perspective, Misra sees the monopolistic power of large pharma companies lessening. These firms’ stock prices have either stayed the same or gone down since the beginning of the coronavirus outbreak, whereas biotech has moved up. Telehealth has exploded, changing the entire landscape of the healthcare field.
However, what could potentially inhibit the growth of healthcare and other fields is the trend away from globalization. Prior to the pandemic, many companies eliminated redundancies in their supply chains. That proved unwise, and as a result, he sees many firms focusing on becoming self-sufficient, which will put a strain on both cooperation and R&D, as well as the ability of technologies, innovations and services to effectively scale — a phenomenon Misra sees further perpetuated by the fact that it is an election year, and the U.S.-China relationship is front and center.
“The unwinding of globalization is going to happen. Mark my words,” said Misra. “Which is a shame because countries believe they need to have their own infrastructures, their own companies, rather than knowledge sharing and economic efficiency, which came from scale.”
To conclude, Misra delved into the ways Softbank has helped its portfolio clients around the world handle the repercussions of the coronavirus, consolidating it into two key points: Make sure you have enough cash runway for 18 to 24 months. Focus, and tamp down your burn rate.
And, look ahead.
“Rethink strategy right now and invest a little in technology so, when we come out of this, your market share goes up,” he said.
Megan O’Brien is Brainyard’s business & finance editor, covering the latest trends in strategy for CFOs. She has written extensively on executive topics as a former content creator for Deloitte’s C-suite programs. Got thoughts on this story? Reach Megan here.