Risk Always: Why a Placid Present Day is a Facade
Bankruptcy rates in the U.S. are in steep decline. Vaccines are helping not only at-risk individuals move past COVID-19 but American commerce itself, according to Bloomberg. Chris Ward, a bankruptcy lawyer with Polsinelli PC, took the rosy outlook a step further: “There’s no distress in the economy right now -- it’s pretty amazing.”
It’s easy to declare “risk on,” yet a wise risk analyst understands that a strong credit culture should always be maintained. What’s more, though in-court bankruptcies are falling, corporate debt is rising to new heights at the same time. Bankruptcies were triggered at a feverish rate in Q2 2020; the reprieve, one year later, feels more like a crisis delayed than dismissed. We will illustrate why it is just as important to remain vigilant today as it was during the depths of the pandemic, as so many financial professionals are misjudging their risk exposure level.
"In nature, predators are the natural check on prey populations like wolves and deer. Removing predators allows excessive growth in prey populations. In credit, interest rates are the predatory force against excessive lending, making it expensive to own debt that cannot be applied for productive use in terms of cash flow generation. The decade-plus of extremely low interest rates removed that predator resulting in wild expansion of the number and magnitude of indebted companies and setting the stage for a major snapback. This feast/famine credit cycle repeats consistently, but this version is uniquely positioned within public, non-financial corporations worldwide, making it paramount for B2B risk professionals to pay attention right now. Don’t prepare while you’re under fire," Jerry Flum, CEO of CreditRiskMonitor. Illuminating Jerry’s point, in the U.S., 2020 non-financial corporations issued $1.7 trillion of bonds, surpassing the previous high by almost $600 billion, and as of Q1 2021, total debt reached $11.2 trillion, equivalent to over 50% of the entire U.S. GDP.
2021 could very well be defined as a time of collective false sense of security when CNBC analysts cited job recoveries and stimulus as re-establishing the economic growth of the prior decade. To the optimists, COVID-19 was anomalous – the once-in-a-lifetime blip that slowed an upward trajectory seemingly without end. Cycle? What cycle?
Yet we know from history that as surely as the sun rises each day, darkness will eventually come. It always does. And once risk is keenly felt, panic and denial frequently set in. A company having loose credit standards is entirely irrational if there’s an acknowledgment of historic trends. Unless you steel yourself ahead of time against such concerning decision-making and prepare for the fact that other risk professionals will fall prey to herd-minded economic decisions, you could get caught up in the upcoming storm. Michael Flum, CreditRiskMonitor’s President & COO, contends that “companies have been able to avoid distress in the near-term, but the truth is that broader financial leverage only continues to worsen.”
What are some of the major signs of risk that are being, potentially willfully, ignored?
Sign No. 1 - Central Banker Largess
In Q1 2020, federal government debt to U.S. GDP stood at 108% and rose to 129% by Q4. The total federal debt increased from $23.2 trillion to $27.7 trillion, a massive increase in a very short period of time. This fiscal largess isn't isolated to the U.S., as countries around the world have raised fiscal stimulus to jump-start their economies to bridge the gap caused by COVID. This debt isn't going to go away of its own accord and when it comes time to clean up government balance sheets there will be a major reckoning. It can result in higher taxes, rising inflation, outright defaults, and/or slower economic growth.
Sign No. 2 - Banks and Falling Interest Rates
Governments the world over have also pushed interest rates to historic lows in the pandemic effort. In some countries banks have issued 30-year mortgages with zero interest rates, other banks have loaned money to hedge funds without fully understanding the borrower's risky financial state, and most have materially loosened debt covenant protections on corporate loans and bonds. In many cases, weak companies are being allowed to roll over troubled debt or to defer payments in the vain hope that financial problems go away of their own accord. Low rates fundamentally distort the decision-making process, particularly because they dissuade companies from controlling risk and support engaging in speculative behavior.
Sign No. 3 - Investors Are All In
Bonds are similarly inflated, with yields on the highest-risk fare (which are called "junk bonds" for a reason) at worryingly low levels. Margin debt has spiked dramatically higher, as well, as investors borrow even more money to purchase expensive financial assets. Capital markets are direct financing sources for public companies. When investors shift en masse to a “risk off” attitude, it will be much harder for companies of all types, but particularly ones with weak finances, to tap capital markets for additional funds. With reduced access to capital, the number of companies in financial distress is likely to skyrocket.
CreditRiskMonitor Can Help
It's our goal to help you identify risk exposure and prepare before it wreaks havoc on your business, time, and emotional wellbeing. Never dismiss the existence of this hidden risk because bankruptcy rates are falling. Contact us today so we can help you identify risk inside your portfolio before the tide turns.