Corporates After COVID: Risks, Recovery, and Restructuring
IMF News, April 22, 2021
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- Published: April 22, 2021
Pre‑COVID corporate vulnerabilities
- Global nonfinancial corporate sector debt reached 91 percent of GDP by the end of 2019.
- October 2019 GFSR study of corporate vulnerability (eight large economies) projected corporate debt-at-risk — debt owed by firms that cannot cover their interest expenses with their earnings — would rise to nearly 40 percent of total corporate debt in major economies by 2021.
- Findings anticipated elevated vulnerabilities in the corporate sector even before the COVID-19 pandemic.
Pandemic impact on corporates and policy response
- Between the end of 2019 and the third quarter of 2020, global nonfinancial corporate debt increased by a further 11-and-a-half percentage points of GDP.
- Corporate responses to cash-flow squeezes included cutting employment, delaying capital investment, running down cash buffers, drawing on bank credit lines, and increased bond issuance by firms with market access.
- Extraordinary policy support included central bank and government direct funding programs, government loan guarantees, and measures to support firms and banks.
Heterogeneity of stress: liquidity, solvency, viability
- Liquidity stress (ability to pay short-term obligations without new external financing) is high at small firms in most sectors and across countries.
- Solvency stress (ability to meet short- and long-term obligations) is high at small, mid-sized, and even large firms in sectors most affected by COVID-19.
- “Viability risk” is defined as firms unlikely to be profitable within a three-year time horizon.
- Application of the GFSR decision tree to almost 20,000 firms in Advanced and Emerging Market economies found that the share of debt at firms with high viability risk is notable particularly for small corporates.
Banking-sector implications and global stress-test results
- Global stress-test analysis covered 29 systemically important jurisdictions using a sample of 350 banks, accounting for 73 percent of global banking assets.
- The COVID-19 shock reduced banks’ capital by around $400 billion; without policy support (including government loan guarantees and capital adequacy policies) the shock to capital would have been around $600 billion.
- More than 90 percent of banks in the analysis were estimated to remain above statutory minimum capital levels through 2022.
- Surveys indicate banks may have become more reluctant to lend as the pandemic has dragged on, reflecting expected phasing-out of lending-support policies and concerns about credit quality.
Macrofinancial risks and growth-at-risk evidence
- A 10-percentage-point acceleration in nonfinancial corporate leverage buildup is associated with an increase in downside risks to economic growth, in the near term, of about 1 percentage point.
- High corporate leverage historically precedes financial and economic downturns, implying elevated financial-stability risks in the post–COVID-19 environment.
Policy recommendations — near term and medium term
- Replace blanket support measures with targeted and time-bound measures to:
- Mitigate threats to financial stability from the pandemic shock.
- Allow resources of non-viable enterprises to be recycled into the productive economy.
- Promote private investment and credit discipline.
- Facilitate enterprise restructuring and fair burden-sharing when necessary.
- Maintain borrower-support policy measures until the economic recovery is well entrenched, while avoiding supporting non-viable firms indefinitely.
- Tighten macroprudential policies as the recovery takes hold; take early action to tighten selected macroprudential tools given possible lags between activation and full impact.
- Use the proposed “decision tree” to classify firms by liquidity, solvency, and viability risks and guide policy:
- Firms with low liquidity and solvency risks: encouraged to seek market funding to repair balance sheets.
- Firms with high liquidity or solvency risk and high viability risk: should be restructured or liquidated.
- Viable firms with high liquidity risk: encouraged to access market funding; limited market access firms could receive targeted liquidity support (for example, loan-guarantee programs).
- Viable firms with high solvency risk: encouraged to raise equity; lacking market access, consider equity-like support with administrative controls, transparency, accountability, conditionality, and a clear exit strategy.
Corporate debt restructuring, NPL resolution, and legal frameworks
- Some loans will not recover, leading to higher non-performing loan (NPL) levels even with a strong recovery; high NPLs can “zombify” business lines or banks, create negative feedback loops, and erode confidence of bank investors and deposit-holders.
- Key steps to facilitate restructuring and NPL resolution:
- Enhanced prudential regulation and intensive supervision to ensure consistent NPL reporting and prudent provisioning.
- Develop markets for NPLs and attract third-party firms specializing in NPL investments and servicing platforms to enable rapid operational capacity building, outsourcing of recovery operations, disposal of NPLs in the open market, and attraction of fresh capital.
- State-sponsored asset-management companies (AMCs) can help absorb NPLs during systemic crises but must be carefully designed; experience with publicly owned and publicly managed AMCs has been mixed and depends critically on fine design details.
- Robust legal frameworks for insolvencies that enable timely, transparent, and predictable recovery of claims through enforcement and insolvency proceedings while protecting value for all parties.
- Special out-of-court solutions can facilitate effective and timely financial and operational restructuring by private creditors.
- Standardized restructuring solutions can offer simple, less precise and less costly results.
- Simplified court proceedings can reduce cost and use of judicial resources for micro and small enterprises.
Summary conclusions
- COVID-19 has intensified corporate leverage and stress, reinforcing the nexus between firms and banks.
- Continuing policy support is needed but must be better targeted and time-bound to balance near-term recovery objectives with medium-term financial-stability risks.
- Timely, forceful, and well-calibrated policy steps can help repair corporate balance sheets, facilitate restructuring, and open the way toward renewed economic growth with stronger prospects for financial stability.
Remarks by Tobias Adrian, Financial Counsellor and Director of Monetary and Capital Markets Department, IMF, April 22, 2021 — IMF Communications Department