Covid-19 and the credit cycle: 2020 revisited and 2021 outlook

Edward I Altman

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Trends are analyzed for 2020 and 2021 record new issuance and buildup in global and US debt, especially corporate and government levels, during the pandemic.
The remarkable transitions from a benign credit cycle in 2019, to a highly stressed cycle in early-mid 2020, to a return to a benign cycle in 2021 raise the question of how to measure where we are in the credit cycle.
Central banks reacted rapidly and with great success after the onset of the pandemic, limiting the damage done to equity and debt markets and motivating an amazing rebound that has continued to mid-2021; but possibly with unintended consequences as risky debt markets assumed an extreme, but perhaps still rational, "risk-on" profile.
Bankruptcies, defaults and default recoveries are closely analyzed post-March 2020, showing record levels of large US firm bankruptcies in 2020 and a doubling in high-yield bond default rates compared to 2019; followed by a remarkable reversal to low defaults in a benign credit cycle in 2021 – implications for the outlook in 2022–3.
Two other markets and trends are analyzed using Z-score and other metrics: (1) the huge increase in BBB rated debt over the last 15 years and its resulting "fallen-angel" impact in the early and later stages of the pandemic, and (2) the increasing trend of corporate "zombies", globally.

Abstract

This study continues the author’s examination and forecasts as to the impact of Covid-19 on the US credit cycle after one and a half years since the pandemic first began. We explore the enormous build-up of global debt even before the pandemic commenced and the subsequent record debt expansion through mid-2021. New debt peaks, especially for nonfinancial corporate debt, are analyzed as to their potential impact on future default rates and the implications for the US credit markets once again starting a new benign cycle in a continuing low interest rate environment. We ask whether the spectacular success of the US central bank and its monetary policy and secondary-market purchases has also promoted potentially destructive unforeseen consequences for debt rated BBB and below. Large- and small-firm defaults and bankruptcies in both 2020 and 2021 are compared, and our expectations about those firms’ solvency status once the government and central bank supports diminish and are eliminated are examined. Finally, we introduce the concept of global zombie firms and suggest that this growing phenomenon be analyzed more robustly and critically with new criteria and empirical analysis.

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