Brief on Coronavirus and TriLinc Portfolios

Update: May 6, 2020

On May 6, 2020, Gloria Nelund, TriLinc Founder and CEO, and Paul Sanford, Chief Investment Officer, hosted our third webinar on COVID-19 and the financial markets. Click here to watch a replay.


Update: April 16, 2020

On April 16, 2020, Gloria Nelund and Paul Sanford hosted our second webinar on COVID-19 and the financial markets. Click here to watch a replay.


Update: March 26, 2020

On March 26, 2020,  Gloria Nelund and Paul Sanford hosted our first webinar on COVID-19 and the financial markets. Click here to watch a replay.


Update: March 23, 2020

Coronavirus and TriLinc Portfolios

As noted in our update two weeks ago, while the short-term economic focus regarding COVID-19 was on China/Asia and supply chains, the larger effects to the world economy would likely be felt once the virus began affecting the EU and U.S., which collectively represent ~50% of global consumption/demand. As that has occurred over the past two weeks, there have been significant adverse effects on aggregate demand (see more below), which TriLinc is monitoring closely in order to have a clear understanding of how our borrower companies may be affected.

 

Supply (Chain) Considerations

  • According to Capital Economics, Chinese factory activity has continued to steadily recover from the lows of ~3 weeks ago, though aggregate activity appears to still be running ~30-40% below normal. This suggests that the base case of an initial short-term shock to supply, with a gradual multi-week recovery is playing out as expected. (As noted in our last update, TriLinc’s borrowers in Asia were expected to be only modestly affected by the disruption in the short-term, which is what we have seen in practice from borrowers in the region.)
  • Asian trade data appears to be following a similar steady, but gradual, upward trend after the initial significant drop seen at the end of February/beginning of March. (On its own, this is seemingly a good sign for TriLinc’s borrowers, suggesting that negative supply-side effects could be short-term in nature.)

 

 

Demand (Consumption) Considerations

  • Global demand is now the largest concern for policymakers around the world, as well as investors, with Capital Economics forecasting that most economies will see GDP levels down significantly by 10-20% in the first two quarters of 2020. Most of the GDP drop can be attributed to global efforts to contain COVID-19, including aggressive quarantines and social distancing policies that have required many service sector industries to close, with many others operating at minimal levels (see more below). (As noted in our last update, this is seen as the real risk to the global economy, as well as businesses everywhere. TriLinc is spending significant time in contact with its borrowers to ascertain what the magnitude of the demand shock is/will be to their businesses, and how best to provide the financing flexibility needed to manage through the current situation.)

 

 

High-Level Take-Aways

  • The choice of global governments to take very aggressive quarantine and social distancing public health measures has altered the effects of COVID-19 from at first resembling SARS, to now being in unprecedented economic territory (see more below).
  • Initial indicators of demand have dropped materially, as economic activity in many service sector industries has been reduced by an order of magnitude (e.g. 1/10th of prior output).
  • As mentioned in our previous update, authorities have taken health precautions extremely seriously, which is what has triggered the demand shock now taking place. It is critically important that governmental authorities provide fiscal stimulus to cushion the economic blow of their aggressive public health policies.
    • Global central banks have been appropriately vigorous in protecting the financial system, with the U.S. Federal Reserve playing a particularly important role in providing access to U.S. dollars (through swap lines), providing liquidity to the commercial paper market, and recently announcing programs to buy corporate bonds and securitized commercial and consumer loan pools. The ECB has announced further quantitative easing measures, including also buying corporate bonds to ensure (large) businesses have access to the financing and liquidity they require.
    • The pressure is now squarely on elected governments to compose, pass through their legislatures, and implement fiscal support on the scale to match the shock to aggregate demand. At the time of this writing, the U.S. currently has a nearly $2 trillion fiscal package being negotiated in Congress. However, time is of the essence and governments need to move much faster than they are accustomed to in order to mitigate the economic fallout of their aggressive public health policies.
  • The duration of the aggressive public health policies and the scale of the fiscal stimulus response will be determinative in how deep of an economic contraction the global economy experiences and, consequently, how quickly a recovery takes place.

 

 

General Economic Effects

Below is an update on the key data metrics that TriLinc is closely monitoring:

  • Purchasing Managers Index (PMI) and trade flow data updates, particularly for Asia. PMIs and trade flows can not only be used as an advance proxy for GDP, but also to better understand some of the deeper-company level effects that may be taking place.
    • According to Capital Economics, PMIs and trade flow data show that initial forecasts of a significant short-term disruption to regional output and trade, followed by gradual recovery, is taking place.
    • The risk has now shifted to how significantly reduced demand (particularly from the U.S. and EU) may hurt PMIs again, but now from a drop in demand vs. the initial shock to supply from Asian factory closures and restrained trade.
  • Economic activity in China. Even for investments with minimal direct exposure to the country (such as TriLinc’s), according to the IMF, China represents >15% of global GDP (2nd in the world after the U.S. at >23%) and is a major component of the global supply chain. A large and sustained slowdown in China will likely have significant ramifications for the global economy. According to Capital Economics:
    • Initial data indications from China suggest commercial activity dropped precipitously in the initial weeks following the COVID-19 outbreak.
    • However, activity in March shows commercial activity has bottomed, and a recovery is beginning.
      • Local policymakers are cautiously optimistic that virus has been largely contained; however, an uptick in new cases over the last week has reintroduced the risk that new cases could increase again.
  • Consumption data in the U.S and EU. has begun to track to the downside case. While China is ground zero for the supply side of global trade, the U.S. and EU drive the demand side. The U.S. and EU are the 1st and 2nd largest consumer markets globally, accounting for ~50% of global consumption, according to the World Bank.
    • The choice of policymakers to implement unprecedentedly aggressive quarantine and social distancing measures has had a devastating effect to spending/demand and early statistical results are alarming.
      • According to Capital Economics, initial jobless claims have surged to 8x the prior 4 week moving average with consumer confidence dropping more than 1/3rd.
  • Policy makers’ responses. Governments and central banks have the ability to cushion economic shocks through stimulative monetary and fiscal policy.
    • Monetary policy has been active early and often to keep the liquidity needed for the global economy to operate available.
    • Several fiscal stimulus packages have been announced, which is positive; however, much more remains to be done. The U.S. (first and foremost), the EU, and China are the governments with the fiscal firepower to deliver the size of stimulus likely required – estimates range globally from $5-10 trillion, based on a relatively short duration of the current aggressive quarantine and social distancing public health policies. Should businesses remain significantly restricted for longer, the economic risk of the drop in demand becoming self-reinforcing may increase materially, particularly through job losses and the bankruptcy of small and mid-size businesses.

 

In closing, we continue to closely monitor the COVID-19 situation and its potential effects in an effort to minimize disruptions to our borrower companies and safeguard our investors’ capital.

 


March 9, 2020

Brief on Coronavirus and TriLinc Portfolios

TriLinc has minimal direct exposure to the economic areas that appear to be suffering most (mainland China, S. Korea and Japan in Asia, and Italy and Iran in Europe/Middle East), but a short and sharp contraction in economic activity may have a transitory effect on our borrower companies.  If the panic passes relatively quickly (as with SARS), there doesn’t currently appear to be too much long-term risk for our borrowers.  However, if general economic activity deteriorates for an extended period of time, resulting in a severe global recession, everyone will be affected.

As TriLinc does not currently have significant exposure to the economies that appear to be directly affected most, our analysis is focused on second and third order effects (i.e. global trade flows and specific industries that may be more affected generally).  In addition to our macroeconomic reviews and analysis, TriLinc is in close contact with its local market investment partners in order to receive real-time feedback of effects on both local economies and our borrower companies.

 

Adverse Considerations

ECONOMIC
  • Many Chinese factories were shut for several weeks until just last week, when the first factories that had been closed re-opened.  (TriLinc has minimal direct exposure to China, and supply chains with links to Chinese factories can be managed by most TriLinc borrowers.)
  • Tourism in Asia appears to have been significantly affected, which hurts Thailand in particular because tourism is a significant portion of their economy.  (TriLinc has no direct exposure to Asian tourism-related industries.)
  • Trade (particularly in Asia) has likely fallen significantly in Q1 2020 – per Capital Economics, China-S. Korean trade is likely down by a large amount.  (This is the area that could affect TriLinc borrowers either directly or indirectly if it continues over time.  Again, real economic data won’t come out in meaningful amounts for the next few weeks.)

 

HUMAN BEHAVIOR
  • The SARS panic is understandably being used as a proxy for COVID-19, and short-term activity all but ceased in many parts of Asia during the SARS outbreak – well beyond logical/practical expectations.  If behavior this time mimics that of the SARS episode, there will likely be a severe contraction of regional economic activity for Q1.  (Again, it is important to emphasize economic data is measured and reported with a lag, so TriLinc is keeping close watch on the data to see if behavior follows the SARS episode.)

 

 

Favorable Considerations

ECONOMIC
  • Policy makers in the region have already responded in force.
    • Monetary stimulus:  China, Philippines, Thailand and Indonesia have already cut interest rates and S. Korea is expected to imminently.
    • Fiscal stimulus:  Singapore and Taiwan have already announced packages, and Indonesia, Hong Kong, Malaysia and S. Korea are expected to announce packages imminently.
  • China’s containment efforts (while drawing significant human rights criticisms) appear to be working and other countries are taking health precautions seriously.
    • This could shorten the duration of the expected economic contraction – though it could deepen it for a short period, if authorities use extremely conservative quarantine strategies.

 

HUMAN BEHAVIOR
  • Again, using SARS as the nearest and best current proxy, while people tend to panic and overreact in the short-run, the bounce back once the panic subsides also may be sharp.

 

 

High-Level Take-Aways

  • SARS is likely the best current proxy we have and it had a short, but sharp, contraction in economic activity with a relatively quick bounce back, as authorities got the situation under control and people recovered from initial panic.
  • Economic data is just beginning to come out; TriLinc is watching it closely to see how closely the COVID-19 outbreak ultimately resembles SARS.
  • If anything, authorities (especially China) are taking the coronavirus much more seriously than they initially took SARS, including:
    • how seriously the medical/quarantine aspects are being handled,
    • and economic policies (both monetary and fiscal) being implemented quickly
  • TriLinc has minimal direct exposure to the economic areas that appear to be suffering most (mainland China, S. Korea and Japan in Asia, and Italy and Iran in Europe/Middle East), but a short and sharp contraction in economic activity may have a transitory effect on our borrower companies.  If the panic passes relatively quickly (as with SARS), there doesn’t currently appear to be too much long-term risk for our borrowers.  However, if general economic activity deteriorates for an extended period of time, resulting in a severe global recession, everyone will be affected.

 

Along with our local Investment Partners who are on the ground, we continue to monitor the situation closely and will provide regular updates as available, so, please continue to check back.

 

 

General Economic Effects

It is important to note that economic activity affected by COVID-19 is taking place in real time, while economic data is being compiled, analyzed and reported with a lag.  Therefore, monitoring of the economic effects of the disease will be ongoing for an extended period of time.  That said, there are several economic indicators TriLinc is monitoring, including:

  • Purchasing Managers Index (PMI) and trade flow data updates, particularly for Asia. PMIs and trade flows can not only be used as an advance proxy for GDP, but also to better understand some of the deeper-company level effects that may be taking place.
    • While a significant amount of data is just being compiled and reported now, according to Capital Economics, initial readings of PMIs and trade flows suggest a significant short-term disruption to regional output and trade.
    • How long the decline is sustained will determine how impacted the global economy becomes. In prior health crises (e.g. SARS), initial contraction in economic activity and trade were significant, but so too was the rebound.
  • Economic activity in China. Even for investments with minimal direct exposure to the country (such as TriLinc’s), according to the IMF, China represents >15% of global GDP (2nd in the world after the U.S. at >23%) and is a major component of the global supply chain.  A large and sustained slowdown in China will likely have significant ramifications for the global economy.  According to Capital Economics:
    • Initial data indications from China suggest commercial activity dropped precipitously in the initial weeks following the COVID-19 outbreak.
    • However, early indications in March provide the possibility that commercial activity has bottomed, and a recovery is beginning.
    • The uptick in activity is believed to be driven by a large drop in new cases of COVID-19, suggesting China’s authorities may have been largely successful in their aggressive quarantine policies.
      • New cases of COVID-19 need to be watched closely to understand if commercial activity in China has, in fact, bottomed with a sustained recovery initially underway.
  • Consumption data in the US and EU as COVID-19 plays itself out globally. While China is ground zero for the supply side of global trade, the U.S. and EU drive global consumption (1st and 2nd largest consumer markets globally, accounting for ~50% of global consumption, according to the World Bank), which drives demand.
    • At this point, it is too early to tell what effect COVID-19 will have on U.S. and EU global trade demand/consumption, but these indicators should be watched closely.
  • Policy makers’ responses. Governments and central banks have the ability to cushion economic shocks through stimulative monetary and fiscal policy.
    • Asian economies have been quick to announce aggressive policy responses, particularly China, Hong Kong, Indonesia, Malaysia, S. Korea, Philippines, Singapore, Taiwan and Thailand.
    • The G7 also announced they are committed to “use all appropriate policy tools to achieve strong, strong, sustainable growth and safeguard against downside risks”.

 

In closing, we are closely monitoring the COVID-19 situation and its potential effects in an effort to minimize disruptions to our borrower companies and safeguard our investors’ capital.

 

 

Additional Information on Coronavirus

The coronavirus, which was first reported in China in late 2019 and is named “SARS-CoV-2” – but is also known by the name of the illness it generates, “COVID-19” – is from a family of viruses that include other well-known viruses, such as SARS (first reported in 2003) and MERS (first reported in 2012).  For purposes of this note, we refer to the illness as “COVID-19”, though some other sources may use COVID-19, SARS-CoV-2, and “the coronavirus” interchangeably.

 

 

Health and Safety Information

The U.S. Centers for Disease Control (CDC) maintains an active webpage for COVID-19, which contains:

  • background information,
  • the source and spread of the virus,
  • a summary of the current the situation in the U.S.,
  • severity of the illness,
  • an assessment of public health risk,
  • potential paths the disease could take,
  • the CDC’s response,
  • CDC’s recommendations, and
  • other available resources for more information.

 


Additional Commentary from McKinsey & Company:

McKinsey & Company maintains a webpage with insights into the coronavirus outbreak and its impacts on the global economy. Click to read COVID-19: Implications for business.

DISCLAIMER

The statements and opinions expressed in this article are those of the McKinsey & Company. The information contained in this article is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TriLinc cannot guarantee the accuracy or completeness of any statements or data. The information contained in this article is accurate as of the date submitted but is subject to change.