One of the primary concerns about the near-term impact of the COVID-19 outbreak is that the economic disruption could freeze up the credit market. On Tuesday, credit rating agency S&P Global warned investors the coronavirus fallout will trigger a global recession and create “intense credit pressure” for distressed companies.
In a note on Tuesday, analyst Alexandra Dimitrijevic said the perfect storm of plummeting cash flows, tight credit markets and an oil price shock will negatively impact creditworthiness.
“These factors will likely result in a surge in defaults, with a default rate on nonfinancial corporates in the U.S that may rise above 10% and into the high single digits in Europe over the next 12 months,” Dimitrijevic wrote.
Where To Watch For Defaults
She said the credit crunch will start in the industries and asset classes most impacted by the current situation, such as energy, airlines, transportation, leisure and gaming, hotels and restaurants, and retail. However, if the recession is prolonged and the economy does not experience a V-shaped recovery, Dimitrijevic said the credit crunch could spread to other industries as well.
“Companies rated 'B-' and below will likely suffer most from financing needs and rapid rating transitions,” Dimitrijevic said.
The potential for a tightening credit market and corporate defaults is one of the reasons the SPDR S&P 500 ETF (NYSE: SPY) is down 29.3% overall in the past month.
For now, S&P said the strength of bank balance sheets are the key to maintaining a liquid credit market and the creditworthiness of their borrowers. Dimitrijevic said most major banks should be able to navigate tighter funding conditions for the time being, but certain nonbank financial institutions may have a tough road ahead.
For more than a decade, companies have had easy access to credit at historically low interest rates, creating one of the best environments for starting and growing businesses in history. However, the easy credit conditions have allowed companies with broken and unproven business models to thrive along with the rest of the market, and those companies may soon have to survive on their own without access to outside capital.
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