The Impact of the COVID-19 Pandemic on the Credit Market: Review on Current Situation
Coronavirus disease has affected a multitude of government and business areas. The credit market is no exception.
At the moment, there is widespread uncertainty about the rate at which the coronavirus spreads, when it will hit its peak, and whether there will be a relapse. The same uncertainty is characteristic of the credit market.
In this article, we have reviewed the latest credit market research by leading financial analytics companies. The results of the research and the figures we obtained helped us to describe the current situation of the credit market in light of the outbreak of the COVID-19 pandemic.
Current state of the credit market
Measures to contain COVID-19 led to the abrupt shutdown of the economy. The experts of the S&P Global make pessimistic projections for the credit market in this regard: these measures will lead to a global recession.
In turn, the consequences of the global recession will lead to an increase in the number of defaults.
The credit market today is in a state of uncertainty but financial experts are worried that its condition might deteriorate dramatically.
For example, S&P Global, based on the analysis of the pandemic duration, claims that the default rate of non-financial companies in the United States could increase by 10%. As for Europe, the number of defaults could rise critically over the next 12 months.
According to S&P Global analysts, the coronavirus pandemic is the turn of the American enterprise credit cycle. The potential for rating downgrades has grown at a record pace. In the first quarter of 2020, the negative bias increased by 12%.
For both speculative and investment borrowers, the level of a downgrade in the first quarter of 2020 was the highest ever. The only moments in history when ratings fell to such a degree were the Great Recession of the late 2000s and the aftermath of the 9/11 terrorist attacks.
Financial crisis of 2008 and coronavirus outbreak – do they have the same effect?
The credit market has experienced many crises in modern history. The last major shock the credit market passed through was in 2008 during the global financial crisis. The crisis triggered by the coronavirus outbreak has not yet caused losses we witnessed in 2008 but already raises many experts’ fears of a strong downfall in the credit market.
Based on the available data on the state of the credit market, we can conclude that the events are developing similar to the scenario of 2008. IHS Markit, based on market data on March 20, 2020, developed a curious diagram that compares the development of the 2008 crisis and the decline of the economy caused by the COVID-19 outbreak. The vertical line on the chart is marked by the collapse of Lehman Brothers (September 15, 2008).
Source: IHS Markit, MSCI
From the IHS Markit chart it is clear that although the crisis provoked by the COVID-19 outbreak has not yet reached the critical point of the financial crisis of 2008, events are developing almost at the same tempo.
Analyst company MSCI did an interesting study. Their experts conducted a stress-test, where they suggested that credit and stock markets would fall in the same way as in 2008-2009.
As a result, MSCI produced forecasts that U.S. stocks could lose 25% of their share, U.S. Treasury yield over the past 10 years might fall by 30 basis points. U.S. credit spreads might increase to 2008 levels. And this will cause spreads of 50% and 70%.
Scenarios in various credit sectors
The crisis caused by COVID-19 will affect various credit sectors in different ways.
The chart below shows the impact of the COVID-19 crisis on various industries today with the assumption of its further expansion. The diagram is based on the MSCI stress-test we mentioned before.
According to the stress-test results, companies from the information technologies and health care sectors might be hurt the least. But the energy and financial companies are much more vulnerable to the crisis.
S&P Global figures that the decline in global demand will slow cash flow in many industries, which will negatively affect circulating capital, balances of cash flow, and the ability of credited parties to maintain operations.
The credit crunch impact will vary. The production sector, airlines, transportation, leisure, gambling, hotels, restaurants, and retail will take the biggest hit, states S&P Global.
The analysts also affirm that investment-grade companies will be the most resilient to the crisis and flexible in dealing with the consequences of the economic slowdown.
Factors that cause a credit market freeze
According to the research of S&P Global, a drop in oil prices, tighter financing conditions and a drop in cash flows will occur in the next few months. These are factors that have a serious influence on the credit market.
Let’s look at these factors separately.
Against the background of the coronavirus outbreak, we observe a dramatic drop in oil prices, which in turn strongly affects the credit market. Demand falls, supply agreements are being torn up. This situation means a surge in defaults among enterprise borrowers.
As a consequence of the pandemic, the circulating capital of many industries will suffer, as the collapse of demand will cause a suppression of the movement of cash. Companies will find it much more difficult to conduct business. Therefore, to stabilize the situation, a lot of enterprises will apply for credit support to the State.
Cash flow will also slow down because of dividend and investment cuts. Such instability will lead to a constriction of the conditions of State financing. Without the support of the government, many enterprises will become bankrupt. However, with the tightening of the conditions of State financing, central banks will be able to avoid the problem of default.
At the end of our review of the current credit market situation, we can draw the following conclusions:
- The key factor in maintaining creditworthiness during the crisis is the stability of the bank balance sheet. Every country, like every single enterprise, will emerge from this pandemic in various ways. The economic impact of COVID-19 will depend on the quality of their assets and income.
- The duration of the pandemic, as well as economic stability and the adequacy of policy measures, will play a key role in the situation of many countries and their credit market. Now, we are witnessing a serious economic downfall. It will touch weaker credit institutions. But if the recession drags on, the consequences could be much wider.
- Many countries will face high health expenditures, deteriorating economic conditions for citizens, and declining tax revenues. In such a situation, the impact of the credit market will depend on how the country is exposed to coronavirus, on oil prices, and on their fiscal flexibility.
The situation with COVID-19 is constantly changing. Developments in the field of credit market take place with incredible speed. Therefore, you need to always stay alert and watch the updates of economic and credit reviews.