The financial impact of COVID-19 on firms’ ability to meet their financial obligations is likely to be severe for many according to new research.
Analytics firm RapidRatings has conducted a multi-faceted stress test on the portfolios of public and private third parties, suppliers, borrowers, and other counterparties to model potential outcomes of the COVID-19 crisis.
“The combined effects of the COVID-19 medical crisis, economic and political disarray, and tightening credit cycles means there are more unknowns than knowns for supply chain actors,” said James Gellert, Chairman & Chief Executive Officer of RapidRatings. “The RapidRatings COVID-19 Stress Test provides a sobering look at the global business landscape, starkly reflected higher probabilities of default.”
In its scenario analysis, RapidRatings looked to understand the likely impacts of a 15% drop in revenues on the Financial Health Ratings of public and private companies globally. The scenario analysis looked at how companies would be affected on an industry-adjusted company basis, then overlaid macro factors to evaluate how companies would fare through 2027. The macroeconomic adjustments were selected to mirror the troughs of the global economic crisis of 2008.
In order to determine the overall impact of a potential macroeconomic downturn of companies in its global database, RapidRatings applied an additional Transition Probability Matrix (TPM) model for economic stress testing on top of the original 15% revenue reduction. For this stress test, RapidRatings used the 2007-2008 financial crisis as the guide and selected the most adversely impacted levels for GDP (-8%), CPI (0%), industrial production (-14%), unemployment (an increase of 22% per quarter for the following four quarters percentage over pre-pandemic levels), and the S&P 500 Index (-45%).
“The results show a 50% increase in probabilities of default (i.e., the likelihood that a borrower will not be able to make its debt obligations over a specified time frame- see chart) in the stressed coverage compared to unstressed coverage by the end of 2027,” it added.
The firm said after applying the 15% revenue reduction to financial statements and generating ratings across RapidRatings’ Public and Private company coverage, virtually all companies either suffered a downgrade or stayed in their starting risk categories. The COVID-19 Stress Test revealed that the 15% decrease in revenue across Public and Private company coverage would result in more than half of all global companies (52%) being categorised as High-Risk or Very High-Risk, a 137 percent increase.
“It is clear from the stress test that even if a crisis scenario is modelled that is likely milder than the current pandemic, that risk managers still have their work cut out for them – understanding financial health and deepening collaboration across the supply chain has become more critical than ever,” said Mr Gellert.