London (CNN Business) Companies have spent the years since the global financial crisis binging on debt. Now, as the coronavirus pandemic threatens to push the world into recession, the bill could come due — exacerbating damage to the economy and feeding a meltdown in financial markets.
Looking to take advantage of low interest rates, companies have rushed in recent years to issue bonds whose proceeds could be used to grow their businesses. Corporate debt among non-banks exploded to $75 trillion at the end of 2019, up from $48 trillion at the end of 2009, according to the Institute of International Finance.
As the coronavirus spreads — touching off a plunge in oil prices and a collapse in travel, and shutting factories from Italy to China — there is increasing alarm that companies in the energy, hospitality and auto sectors won’t be able to make their bond payments. That could trigger a spree of ratings downgrades and defaults that would further destabilize financial markets and compound the economic shock.
“This certainly is another match being lit [near] the bonfire of corporate debt liabilities,” said Simon MacAdam, global economist at Capital Economics. “There’s definitely potential for systemic risk.”
The coronavirus shock
Investors became increasingly anxious about corporate debt this week as stocks sold off and crude prices nosedived. The ability to buy or sell securities in corporate debt markets has become much more difficult. And the extra returns that investors are demanding to hold corporate debt over more stable government bonds have shot up, signaling that they’re now viewed as much riskier holdings.
The SPDR Bloomberg Barclays High Yield Bond ETF (JNK) dropped more than 6% this week, while the iShares iBoxx $ Investment Grade Corporate Bond ETF fell more than 8%. Bank of America told clients on Friday that volatility had skyrocketed and outflows from corporate bond funds were at record highs.
The anxiety is pegged to companies that rely on stable energy prices and tourism to generate cash. When business gets tougher for these firms, it could prevent them from servicing their debt, leading to defaults. Ratings agencies could also start downgrading many of these companies, forcing some bondholders to sell.
“Default and downgrade risks have increased to their highest levels since the start of the current business cycle,” Lotfi Karoui, chief credit strategist at Goldman Sachs, told clients this week.
Much of the risk lies with energy companies, which have ramped up borrowing in recent years to build pipelines and fund other projects. Those companies now face acute pressure due to plummeting oil prices, which have dropped 50% since early January amid evaporating demand for fuel and the implosion of an alliance between major energy producers Saudi Arabia and Russia that had helped prevent oil from flooding onto global markets.
“Oil producers who were depending on the higher prices to pay back their loans so they could drill for oil are under a significant amount of stress,” said Andy Lipow, president of Lipow Oil Associates, a consultancy based in Houston.
Investors dumped shares this week in two US energy companies that Morgan Stanley said are at risk of default within the next year: Chesapeake Energy (CHK) and Whiting Petroleum Corporation (WLL). Chesapeake’s stock fell to 15 cents on Thursday, while Whiting shares closed at 75 cents.
Airlines, hotels and cruise lines are also in trouble as restrictions on movement grow and more people hunker down at home. A ban on travel from Europe to the United States, announced by the Trump administration on Wednesday, eviscerated airline shares. Budget carrier Norwegian Air, which is heavily indebted, said it would temporarily lay off up to half its workers after its stock dropped 22% on Thursday.
“Coronavirus’ rapidly increasing effect on air travel is placing downward pressure on global airline credit profiles, especially as there are risks that demand takes materially longer than previous shocks to recover,” Fitch Ratings said Thursday. It is monitoring American Airlines (AAL), which has a significant amount of debt, as well as Alaska Air (ALK), which is based in Seattle, the site of a significant outbreak in the United States.
Source: Julia Horowitz | CNN Business
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