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Home›Accounts›Breakingviews – Default wave will hit little guy hardest

Breakingviews – Default wave will hit little guy hardest

By Shirley J. Speights
March 9, 2021
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A shuttered ice cream truck sits on the National Mall, largely empty of tourists during the coronavirus disease (COVID-19) outbreak in Washington, United States, May 22, 2020. REUTERS / Jonathan Ernst

LONDON (Reuters Breakingviews) – The pandemic has put companies in debt in most countries around the world. Large companies with reserves and access to capital now appear to be able to cope. Small businesses are at much greater risk of default.

When it comes to the bond market, the coronavirus crisis has been a short-lived affair. The lockdowns resulted in the collapse of the company’s revenues and increased debt levels. The average leverage of rated U.S. companies in the leisure sector, for example, doubled to about 12 times EBITDA in the six months to June, according to ING. Around the same time, Moody’s Investors Service estimated that global default rates could, in a pessimistic scenario, reach 16% in the coming year.

Some faults have arisen, including US retailers Neiman Marcus and JC Penney. Creditsights analysts put the US 12-month default rate in November at just over 7%. But the crisis has eased thanks to bailouts, reopening of economies and companies raising new debt and equity. Federal Reserve Chairman Jerome Powell and other central bankers cut rates to zero and grabbed bonds, forcing investors into riskier debt just to earn a return above inflation. The year 2020 saw the second largest flow of funds into junk debt on record, according to analysts at Deutsche Bank. Their Citigroup peers expect the U.S. high yield bond default rate to fall to just 3.4% in 2021, below the level of around 4% in 2019, according to Moody’s.

Far from the high-cost capital markets, things are less rosy. Small businesses tend to have less diversified incomes and depend on banks for funding rather than bond investors. Even though high-yield borrowers pay less interest, the proportion of US banks tightening credit standards is near its highest level since 2009, according to the Federal Reserve senior loan officer survey. About a tenth of small and medium-sized businesses across Europe could collapse over the next six months, McKinsey said in a November report.

Governments have helped by giving corporate tax breaks and guaranteeing debt. But in the UK, for example, up to £ 23bn of a potential £ 74bn of state-guaranteed debt could be unsustainable, according to a CityUK report.

The small business crisis is significant. Bigger, more financially sound groups can simply crowd out struggling competitors. Starbucks, for example, is raising wages, potentially making life even more difficult for rival local cafes. To avoid continued attrition, governments may need to extend cheap debt programs for longer or even cancel loans. Another option could be to offer tax breaks to stimulate investment. With public debt also increasing, this could require difficult budget choices in 2021 and beyond.

– This is a Breakingviews prediction for 2021. To see more of our predictions, click here

Breakingviews

Reuters Breakingviews is the world’s leading source for financial calendar information. As the Reuters brand for financial commentary, we dissect big business and economic stories from around the world every day. A global team of around 30 correspondents in New York, London, Hong Kong and other major cities provide real-time expert analysis.

Sign up for a free trial of our full service at https://www.breakingviews.com/trial and follow us on Twitter @Breakingviews and to www.breakingviews.com. All opinions expressed are those of the authors.


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