Credit Markets & Coronavirus
The effects of the coronavirus pandemic now seem likely to push the world economy into recession, with full-year global growth of just 1-1.5%. Combined with the collapse in oil prices and extreme capital markets volatility, this will likely mean a surge in defaults among borrowers we rate. Stay updated on the latest news around credit markets and COVID-19 with this digest, updated daily.
Published: March 2, 2020
COVID-19 Credit Update
A global recession presages a spike in default rates. In our view, it seems likely that the sudden stop to the global economy caused by COVID-19--and the drastic efforts to contain it--will lead to a global recession. Combined with the collapse in oil prices and extreme volatility in capital markets, this will inevitably have severe implications for credit markets. In S&P Global Ratings' view, this will likely mean a surge in defaults, potentially reaching a double-digit speculative-grade default rate for nonfinancial corporates in the U.S. and a material increase to high single digits in Europe over the next six to 12 months.
Collapsing demand threatens a cash flow slump. Central banks will likely prevent systemic failures in the financial system by cutting rates to zero or lower, injecting liquidity into the system, and implementing measures similar to those after the global financial crisis to lessen risk.
Key Takeaways:
- The sudden economic stop caused by COVID-19 containment measures will lead to a global recession this year.
- A cash flow slump and much tighter financing conditions as well as the simultaneous oil price shock will hurt 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.
- The magnitude of the impact will vary significantly by industry and asset class. A severe but relatively short-lived economic contraction (our base case) will mostly affect the weaker credits or those in the most directly exposed sectors. But a prolonged recession, beyond our base case, would have broader implications.
Economic Research
Since our last update, which was on March 3, the spread of the coronavirus has accelerated, and its economic effect has worsened sharply. Economic data remains scarce, but the long-awaited initial figures from China for January and February were much worse than feared. The spread of the virus, which the World Health Organization declared to be a pandemic on March 11, appears to be stabilizing in much of Asia. However, the increasing restrictions on person-to-person contact in Europe and the U.S. have sent markets reeling as risk-aversion rises and views on economic activity, earnings, and credit quality deteriorate sharply. As a result, we now forecast a global recession this year, with annual GDP rising 1%-1.5%.
Key Takeaways:
- As the coronavirus pandemic escalates and growth heads sharply lower against a backdrop of volatile markets and growing credit stress, we now forecast a global recession this year, with 2020 GDP rising just 1.0%-1.5%. The risks remain firmly on the downside.
- The initial data from China suggests that its economy was hit far harder than projected, though a tentative stabilization has begun. Europe and the U.S. are following a similar path, as increasing restrictions on person-to-person contacts presage a demand collapse that will take activity sharply lower in the second quarter before a recovery begins later in the year.
- Central banks have swung into action and are undertaking some combination of sharply reduced policy rates, resumed assets purchase and liquidity injections. Fiscal authorities have generally lagged but have begun to loosen the purse strings; we suspect that larger and more targeted spending to the most affected groups is forthcoming.
Stress Scenario
The COVID-19 pandemic looks set to far surpass the infection rate of any other epidemic in living memory, and well over a 100 countries are now infected. World Health Organization officials have declared that Europe is now the epicenter of the pandemic, reflecting its rapid spread globally. The ramifications for economies worldwide are now material, with a considerable likelihood of a global recession.
Key Takeaways:
- COVID-19 will take a major toll on the world's largest tourism exporters.
- We have run 122 of our rated sovereigns through three scenarios--"limited", "extensive", and "extreme"--under which tourism receipts decline by 11%, 19%, and 27% as per similar stresses modelled by the International Air Transport Association (IATA).
- Despite the uncertainty, under our baseline expectation that this is a one-year shock, most sovereign ratings would be resilient to a temporary slide in tourism flows.
Real Estate
Real estate took a major hit this week as growing coronavirus concerns metastasized into market panic, which was then fueled by President Donald Trump's ban on travel from Europe.
The toll on real estate investment trusts was a little lighter than on the broader stock market, and it remains the second-best-performing sector year-to-date of the 11 in the Global Industry Classification Standard, according to S&P Global Market Intelligence data. Year-to-date through March 12, the SNL U.S. REIT Equity index fell 20.5%, while the S&P 500 dropped 23.2%
COVID-19 will cause a significant decline in global RevPAR, cash flow, for rated lodging companies
RevPAR in the U.S., Europe, and Asia will decline for as long as leisure and business travel is postponed or cancelled due to fear of COVID-19.
Most rated lodging companies have substantial flexibility in leverage measures compared to downgrade thresholds, and in cash flow generation, and can reduce spending on shareholder returns and other investments.
Energy
Utility stocks have weathered the market selloff better than many others, but the broad coronavirus-induced collapse in equity prices could carry some consequences for the sector, according to UBS analysts.
Customer growth and capital spending drive earnings for the utilities sector, along with regulator-determined return on equity and a company's capital structure, the bank's analysts said. It is the last metric, the companies' use of debt and equity to finance growth projects and operations, that could raise concerns for some gas utilities and make certain stocks in the space more attractive than others, in UBS's view.
Coronavirus: The Global Impact
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Corporates
The credit ratings on Korean companies were already squeezed before COVID-19 shuttered cities and toppled supply chains, and matters are deteriorating quickly. The World Health Organization on March 11, 2020, defined the outbreak as a pandemic, noting there were 118,000 infections in 114 countries. Korea is unusually exposed. It is a coronavirus hotspot and its companies are highly dependent on global trade. S&P Global Ratings has a negative outlook on almost one-quarter of the Korean companies we rate, and we expect COVID-19 will have far-reaching ratings implications for Korean firms.
Coronavirus is not the only headline for corporate Australia
While the COVID-19 outbreak has dominated recent headlines, the recent reporting season reminds us that many other factors are in play for corporate Australia. Mergers and acquisitions (M&A), low interest rates, bushfires, and drought all moved the needle on second-half results to December 31. However, S&P Global Ratings believes the coronavirus epidemic looms as the most significant threat to operating performance in 2020.
