Weekly Macro Update: Why it’s so Hard to go Bankrupt… And Why That Will Change
There are times when it's hard to keep a company afloat, and then there's the current global pandemic, when it's apparently hard to go bankrupt. But pay close attention next year, when the world’s chief financial officers will face much more complex challenges to keep their firms afloat.
So far, the economic brunt of the pandemic has fallen on small businesses shuttered amid lockdown measures and the millions of people tossed out of work. Comprehensive policy action, however, has managed to keep most firms with access to credit markets awash in liquidity and unconcerned about rolling over debts, even in the face of uncertain demand.
In fact, European and U.S. firms have amassed liquidity buffers that could easily cover a shock many times larger than the Global Financial Crisis in 2008, according to our analysis. European firms have been shoring up their short-term assets over the last two decades, while they and their U.S. counterparts took full advantage of all the cheap credit and subsidies their governments helped orchestrate.
EU & U.S. BUFFERS
Source: Bloomberg. Haver. As of November 30, 2020.
This makes it relatively easy to conclude that a major shock to the system—say, an unexpected mutation of the virus that requires new lockdowns or a sudden outbreak of Middle East hostilities—would be unlikely to trigger a systemic cascade of defaults and bankruptcies. Never say “never,” but it’s hard to imagine.
The much harder question is what will happen under the far more likely scenario as firms return to normal next year and the systemic help begins to fade away? For now, we expect still more support when the European Central Bank announces its plans for expanded asset purchases on December 10. And Treasury Secretary-designate Janet Yellen signaled she is ready to act to address economic damage she described as “an American tragedy.” Still, firms have to plan on rising calls in the U.S. Congress and elsewhere to begin curtailing government support.
One encouraging element in our analysis is that even with all this short-term liquidity, the maturity of corporate debts has been rising. In the euro area, long-term liabilities have risen to 92% of liabilities, up from 83% in 2008. The average maturity of U.S. investment grade firms now stands above 12 years, compared to 9.5 years in 2004.
Financial markets seem optimistic, too, as equity valuations soar and credit spreads tighten. And most banks look resilient, with a sampling of 350 in 29 jurisdictions weathering the shock projected by the International Monetary Fund well above their regulatory capital ratios.
But a fresh study by the Bank for International Settlements offers a note of caution following an examination of the historical relationship between economic growth and expected default frequencies (calculated from asset prices, market volatility and book values). While bankruptcies so far have been lower than previous averages due to government support, favorable markets and lockdown measures that delay procedures, these economists warn that slower growth may drive bankruptcies next year 20% higher.
TOTAL BANKRUPTCIES BY COUNTRY
Source: Bloomberg. As of December 3, 2020.
Whether bankruptcies spike or not, the good vaccine news and a return to normal will immediately create new headaches and far more complex challenges for corporate managers. If this year was about tapping liquidity and reinforcing IT platforms so employees could work from home, next year will bring more expensive money, less predictable consumers and renewed trade friction.
“If this year was about tapping liquidity and reinforcing IT platforms so employees could work from home, next year will bring more expensive money, less predictable consumers and renewed trade friction.”
Inflation remains an aspiration rather than a worry, so interest rates will not spike in even the most bullish scenarios. Still, firms will find it more expensive to hold so much short-term liquidity and they will need to reassess their options. Some will happily buy back stock or pay special dividends, but others will go shopping amid a likely spree of fresh mergers and acquisitions.
Then there is understanding what the new “normal” means. For financial analysis, one accountant calls it “EBITDAC”—earnings before interest, taxes, depreciation, amortization and COVID-19. But consumer patterns were already changing before the pandemic, and firms need to be fast on their feet to understand the shifting accelerating preferences for more online shopping or less business travel. These will have implications far beyond retailers and transportation to reshape some real estate, manufacturing and even commodities producers.
Finally, next year will bring a renewal of trade tensions that the pandemic (and U.S. elections) put on the back burner. President-elect Joe Biden has already signaled he is not ready to remove tariffs on China right away and plans to consult allies first. The souring relations between China and Australia, however, suggest the next chapter will likely be anything but smooth.
It may be a stretch to say that corporate managers will look back fondly on 2020, but their choices are about to turn much more complicated as investors shift their attention from short-term liquidity to solvency and sustainable profits.
Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Any investment results, portfolio compositions and or examples set forth in this material are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this material No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk factors of any Fund/Strategy discussed in this material.
Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).
NO OFFER: The material is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This material is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and must not be construed as a projection or prediction.
Unless otherwise mentioned, the views contained in this material are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual portfolio management teams may hold different views than the views expressed herein and may make different investment decisions for different clients. Parts of this material may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this material is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.
Any service, security, investment or product outlined in this material may not be suitable for a prospective investor or available in their jurisdiction. Copyright in this material is owned by Barings. Information in this material may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.