With a focus on insolvency and default expectations, our team comments on the US economy, the impeachment trial, the pandemic, and global trade strategy.
Navigating the US trade environment has proved to be increasingly challenging amid the health crisis associated with the pandemic, the presidential administration transition, and current economic uncertainty. Atradius has assessed and summarized the primary challenges facing companies and industries today.
US Economy, Consumer Spending and Insolvencies
US Economy
While there is some optimism related to the vaccine roll-out, uncertainty remains. Consensus estimates among analysts and economists suggest GDP growth in 2021 to the tune of 4.2% as the economy recovers during the year helped by significant government stimulus. This implies that GDP will return to its 2019 level by year-end. Recovery in the labour market will take longer. The cost of fiscal stimulus will have to be borne one day by future generations.
Consumer Spending
Consumer spending should improve as the new administration eyes significantly more short-term stimulus creasing the Covid-19 cheque for individuals to $2000. The roll out of the Covid-19 vaccine slows the spread of the virus allowing more businesses to reopen and insolvencies to slow as demand picks up and jobs return, underpinning revived confidence
Insolvencies
2020 insolvencies came in lower than initially anticipated at the start of the pandemic. This was driven by a number of factors, including government stimulus, a strong rebound in consumer spending following the Q2 pandemic-related shutdowns, and stability in bank support. Companies with constrained liquidity following the 2020 shutdowns and demand shifts are particularly vulnerable to potential insolvency events.
Presidential Transition - Impact of Impeachment and Civil Unrest on Business and Trade
Impeachment
Impeachment proceedings are not expected to slow the presidential transition materially to an extent that it will have a meaningful impact on business and trade. However, impeachment proceedings will occupy valuable time in the first few months that could have otherwise been spent on policy changes. Impeachment should not hurt trade unless civil unrest occurs.
Civil Unrest
While civil unrest and potential violence against politicians cannot be fully ruled out in the current climate, its impact on business and trade is expected to be limited. If civil unrest does occur and temporarily stops government, then government spending and stimulus planning may slow. However, once quelled, business and trade should return.
Undoing of Tariffs and Global Trade
The reversal of tariffs imposed by the previous administration would clearly impact supply and demand leading to price implications. Domestic production rates would likely be impacted by the increase in foreign imports. Overseas trade could have a job-offset affect if high paying jobs are lost locally. On the other hand, with prices on imported intermediary goods lower as tariffs are reduced, US producers will gain competitiveness, offsetting the negative impact. A study of the impact of tariffs levied during the previous administration shows that the net results of these two effects suggest that they can be beneficial for the US economy as a whole.
Given the costs and complexity associated with adjusting supply chains, many companies have attempted to diversify supply chain risk following the Covid-19 outbreak and the recent round of tariffs. This may ultimately temper the impact of any potential changes to trade policy.
Covid-19 Impact
Economic Outlook on Trade Credit Risk
Covid-19’s impact will differ from sector to sector. When evaluating the credit risk associated with particular companies, it will be important to continue to evaluate the Covid-19 impact at both the customer and supplier level.
While vaccines are being rolled out, Covid-19 numbers continue to rise with new mutations of the virus emerging. For most industries, improvement is not expected until the number of active Covid-19 cases significantly declines. The speed with which people are being vaccinated is slower than anticipated suggesting meaningful improvement in business for those industries most impacted by social distancing and mandatory closings won’t occur until H2 or later.
Companies and Industries at Risk of Payment Default during the Covid-19 Recession
During the Covid-19 recession, highly leveraged companies with sizeable debt load and upcoming maturities are at a greater risk than well-capitalized companies. Companies that entered the pandemic with healthy well-positioned balance sheets and sound liquidity clearly have enhanced flexibility to navigate temporary periods of decreased demand and increased rates of cash burn.
Companies with decreased levels of borrowing capacity, nearing debt maturities, and significant fixed expenses, have significantly higher probabilities of default. This is evident in the increase in credit rating agency downgrades in 2020 and the continued trend of fallen angels. If the target market is highly impacted by Covid-19 restrictions, smaller and larger companies alike will suffer.
Parts of the economy will continue to profit, such as selected online retailers and the home improvement sectors. However, the retail industry, in general, is at risk and, depending on the outcome of the holiday season could see higher default rates in Q1/Q2.
The hospitality, entertainment and travel industries present a high risk of payment default. Entertainment sectors, such as bars, restaurants, hospitality and theatres, which have been devastated by mandatory business curtailments, will likely suffer the most. For the travel sector, the no-sail orders issued within the cruise industry and the significant drop in air travel demand have resulted in significant increases in debt against material declines in revenues. This has resulted in weaker balance sheets and material cash burn that will likely require a multi-year recovery. The recovery of the airline industry will largely depend on the return of travellers and in what capacity to make airlines profitable, or to at least earn enough to meet their obligations, such as heavy lease payments for airplanes.
In the energy sector, we expect oil prices to move up slightly from the current level of around USD 50 per barrel WTI as demand increases with reduced social distancing over the course of the year. We are already seeing demand being met by increased production. The sector is at risk if oil prices lower or halt upstream business or make continued operations unsustainable, in which case issues will trickle down to suppliers. Later in the year, watch as government looks to regulate and cut back on energy drillers and fossil fuel in favour of green energy.
Also at risk are companies reliant on minimum wage workers. The possibility of a substantial increase in the federal minimum wage, will force businesses to either increase prices, lay-off staff or close their doors. More spending power could be beneficial for the economy as a whole, but could lead to job losses.
SME Insolvencies in 2021
Broad comments are difficult here given the material uncertainty related to the pace of the vaccine rollout. However, insolvencies historically lag economic downturns, so we will likely still see an overall uptick in insolvencies from this group of businesses in 2021. Trade sector challenges and balance sheet strength continue to mark two of the larger variables driving probability of default.
The more Covid-19, the more insolvencies. SME productivity is hit hard when employees who get sick cause a shutdown, resulting in increased employee testing. A strong rebound is expected in H2 as the vaccine settles in and more people become immune, and can safely return to the workforce.
Payment Practices Recovery
Increased Covid-19 numbers and extended partial lockdowns are troubling. Increased debt will need to be addressed via increased taxes thereby hurting investment and returns. The vaccine should help job recovery plus stimulate spending and trade once it is safe to meet in groups again.
This crisis is unlike any other. While government stimulus and the stable lending environment have sustained many marginal businesses through the initial wave of Covid-19 shutdowns, related balance sheets are more vulnerable with significant economic uncertainty on the horizon. In previous downturns, insolvencies continued to increase up to 12 to 18 months after the peak of the crisis. An increase in insolvencies remains a concern, but we are also hopeful that this crisis may follow a different, less severe path when it comes to defaults.