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To date, an unprecedented decline in global oil prices have significantly stressed the global energy sector. The following describes risks that we’ve identified and considered, as well as our outlook for the most important sectors in the global money market issuer universe.
In early March, a series of events unfolded causing an unprecedented decline in global oil prices and significant stress in the global energy sector, at both corporate and national levels. The combination of massive demand destruction triggered by the evolution of the COVID-19 crisis, along with the unraveling of key geopolitical relations, has resulted in utter panic within the oil markets. Barrels of unneeded oil piling up has led to fears that the world is running out of room to store them during the pandemic and as such, oil prices in the futures markets turned negative for the first time in their history. At time of publication, oil prices are still significantly depressed in the spot and futures markets.
Source: Bloomberg data (as of 04/24/2020).
The primary global macroeconomic implications of the oil price shock revolve around the negative impact it has on the capital expenditures (capex) outlook for oil-related sectors, as well as oil producing countries. Global manufacturing was just overcoming depressed conditions caused by the US-China trade war when the COVID-19 crisis surfaced. The loss of demand within the oil industry only adds to the negative outlook for global manufacturers given how closely correlated US manufacturing industry optimism aligns to oil prices (Figure 1).
The oil price shock has negative impacts on global credit markets and continues to cause further tightening of financial conditions. As the credit research team supporting State Street Global Advisors’ Global Cash business, we are most focused on credit issuers that are relevant in the high-quality, short-end investment universe. Major sovereign and corporate issuers whose credit profiles are most directly at-risk in the near term, due to the oil price shock, do not represent material concentrations in global money market funds. As most readers are undoubtedly aware, the global prime money market fund investment universe is heavily concentrated in debt issued by large banks and financial institutions. Indeed, the sell-off in oil prices has increased the risk of loan losses tied to both direct and indirect energy exposures at major global banks. As bank issuers in the global prime money market fund universe have varying levels of exposure to the oil and gas sector, we believe it is important for investment teams to understand the evolving risks in bank loan portfolios brought forth by the COVID-19 crisis and the oil price shock. Our credit research team continues to adjust specific parameters of our credit approval list (most often through changes in maturity restrictions for approved investment counterparties) based on the potential for credit profile deterioration over the near- to medium-term, including considerations of increasing stress levels on oil and gas exposures.
For the purposes of this analysis, we are limiting our definition of the global money markets to non-government funds or funds which take corporate credit risk with the vast majority of their investments. Specifically, we will focus on the following money market fund groups:
As a credit research team supporting State Street Global Advisors’ Cash business, we are most focused on the universe of credit issuers that are relevant in the high-quality, short-end investment universe. As noted above, the plunge in oil prices could negatively impact the credit profiles of certain major sovereign and corporate issuers. However, the entities most at-risk in the near term are not direct holdings in global money market funds, in material concentrations.
For example, as it relates to the oil price shock, financial stress at the sovereign level is currently concentrated in countries with little direct impact in global money market funds. Further, global prime money market fund exposure (as defined in the categories above) to corporations which primary business operations are highly reliant on the oil industry is approximately 9 basis points (bps) of total assets under management, according to Crane Data as of March 31, 2020.
The global prime money market fund investment universe is heavily concentrated in debt issued by large banks and financial institutions. As such, it is most important for prime money market fund investors to consider the oil price shock in that context. As shown in Figure 1, there are material impacts on manufacturing and capex spending from a decline in oil prices. In addition to output, there are employment considerations. For example, according to the Bureau of Labor Statistics, the United States has 12.85 million manufacturing jobs, which employs 8.5% of the total national workforce.1 Thus, a marked decrease in manufacturing activity has negative consequences for employment levels and consumer spending, more broadly. We’d cite negative impacts on macroeconomic activity as a factor to consider, as banking sectors’ profitability and performance is leveraged to the growth of the economies they do business in. Lower growth, including recessions, leads to lower bank profitability, thus lower organic capital accretion, an increase in non-performing loans on banks’ balance sheets and potentially the erosion of banks’ capital bases. So even before considering direct exposures that banks have to companies and customers in the oil industry, we can conclude that the oil price shock will have a negative impact on bank credit profiles, even if modest.
Still, the most important consideration for our credit research team with regard to the impact that the oil price shock will have on the fundamental credit profiles in the banks in the global prime money market investment universe, is the direct exposure that banks have in their lending activities and capital markets operations. To understand the risk, it is important to outline the concentrations of banking system issuers within the current money market fund investment universe, as defined above.
While there are certainly differences in oil industry exposure within banks of particular jurisdictions, banking business models within a country or region tend to have material similarities, especially as it pertains to their direct lending exposures. In the following section, we summarize our team’s perspectives on the fundamental credit profile exposures to the oil industry by each region which bank issuers have a material presence in the global prime money market universe (Figure 2).
Country/Banking System | Prime Money Market Fund Issuer Concentration (%) |
Canada | 13 |
France | 13 |
Japan | 11 |
United States | 9 |
United Kingdom | 5 |
Australia | 4 |
Netherlands | 4 |
Sweden | 3 |
Switzerland | 3 |
Germany | 2 |
Finland |
1 |
Source: Crane Data as of March 31, 2020.
The sell-off in oil prices has increased the risk of loan losses tied to direct and indirect energy exposures at major global banks. As summarized in our analysis, bank issuers in the global prime money market fund universe have varying levels of exposure to the oil and gas sector. While
we see oil and gas exposures as manageable, relative to capital and pre-provision earnings, for the bank issuers’ universe on our own credit approval list, we also recognize the need for ongoing scenario analyses in order to account for changing conditions during the course of the COVID-19 crisis and the oil price shock. Banks on our credit approval list have strong levels of capitalization and liquidity and are stress-tested annually to test the durability of their balance sheets under both economic and markets distress. However, we will continue to adjust specific parameters of our credit approval list (most frequently through changes in maturity restrictions for approved investment counterparties) based on the potential for credit profile deterioration over the near- to medium-term, including considerations of increasing stress levels on oil and gas exposures. Banks exhibiting higher vulnerability in their oil and gas loan books, relative to capital levels, and/or pre-virus challenged business models, will continue to be the focus of our program adjustments, as they have been over the last few months.
For the last two years, our Credit Research team motto has been: “Don’t worry about the end of the credit cycle: be ready for it.” For us that has meant continuing to select cash investment counterparties that are best-equipped to maintain their fundamental credit profiles through
a downturn.
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For four decades, these principles have helped us be the quiet power in a tumultuous investing world. Helping millions of people secure their financial futures. This takes each of our employees in 27 offices around the world, and a firm-wide conviction that we can always do it better. As a result, we are the world’s third-largest asset manager with US $3.12 trillion* under our care.
* AUM reflects approximately $43.72 billion USD (as of December 31, 2019), with respect to which State Street Global Advisors Funds Distributors, LLC (SSGA FD) serves as marketing agent; SSGA FD and State Street Global Advisors are affiliated.
1 www.bls.gov.
The views expreszed in this material are the views of Global Credit Research through the period ended April 27, 2020 and are subject to change bazed on market and other conditions. This document contains certain statements that may be deemed forward- looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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Exp. Date: 04/30/2021