The Significant Impact of Debt to Firms

The following is a guest post by Chris Douthit of OptionStrategiesInsider.com.

The majority of businesses worldwide have been greatly affected by the coronavirus pandemic, while many had already succumbed to its challenges. Currently, it continues to test companies that continue to operate despite the many tests of the pandemic.

Decreasing sales and increasing debt leads companies into much bigger problems in the long run, especially if the pandemic does not end soon.

The decreasing volume of sales reported every period in connection to these businesses’ increasing debt is what is leading them to be buried in debt. If this continues, many businesses will fail as they will not be earning enough profits to cover their obligations.

When due dates come, debtors with insufficient funds will be left with no choice but to try to borrow additional money to pay their current liabilities. This will eventually lead them to have more debt. Here, they become debt burdened companies.

Getting Worse by the Number

Even before the pandemic, the population of debt burdened companies has already been rampant. The population of these debt driven businesses had significantly grown since the start of the pandemic. Now it has gotten worse.

Based on the Bank of International Settlements records, 18% of the country’s total companies have become debt burdened companies.

This number is 14% higher than the total number of debt burdened companies during the last financial crisis. Also, this value is higher than the previous peak that reached 17% in 2001.

That’s higher than the 14% before the last financial crisis … and it’s even higher than the previous peak of 17%, set back in 2001.

These data show that the debt burdened companies have grown and become a troubling matter.

Another alarming issue is that roughly one out of five companies in the U.S. cannot afford their debt.

As many businesses discontinued their operations due to the pandemic, it is challenging for them to get back to business. This means that it is expected that the total number of debt burdened companies will surpass 20%.

The Truth

During this pandemic, the truth about survival is that company bills are being paid through the debt that they continually generate. This is not a solution if you want your business to thrive. Despite having a vaccine against COVID-19, this will not immediately solve the cash issues of businesses of today. The vaccine cannot make the debt go away.

The truth about debt is that it has to be repaid or refinanced when it becomes due.

Shifting to the New Normal

With the threat of the novel coronavirus, businesses are finding ways to prevent COVID-19 transmission by shifting to digital and remote business methods. This means that shifting to a different way of doing business entails additional costs. Additional cost means the need for additional cash.

Debt Will Not be Repaid

With this information, it can be concluded that debt will not end for businesses anytime soon. It will not be repaid. The only way it can be repaid is through the declaration of bankruptcy.

With the pandemic affecting all businesses, including operations, it is expected that the country will see more bankruptcies.

As of the moment, there have been 128 companies across the country that have failed to pay their debt when it came due, based on the credit-ratings agency Standard & Poor’s (“S&P”). During the last financial crisis, 77 companies were reported to have failed to pay their debt on time in 2009. This was the last incident before it reached another high in the second quarter. In the second quarter, 57 U.S. companies were reported to have defaulted on their debt.

Credit Ratings

With more than 2,100 companies that had already downgraded, the default rate can be concluded. Roughly 1,500 downgrades were reported in 2009, or 40% fewer than the 2,100 this time.

The U.S. has 400 weakest links. “Weakest links” is the term used to describe companies with the lowest credit ratings (“B-” or lower). These weakest links are on negative credit watches. Also, they have negative credit outlooks from S&P.

The credit outlooks on companies are relevant to the default rate. The default rate escalates significantly as a company falls down the credit ladder. The default rate of weakest links is more or less five times more than the total high-yield default rate.

With an increasing number of weakest links in a struggling economy, it is expected that the default rate will increase. With this, fear will revert to the stock and bond markets again, especially if interest rates continue to rise.

Those who want to protect their stocks, implementing the covered call strategy would be essential to help eliminate risk and hedge against an additional market selloff. This way, investors can give themselves room to profit when stocks do trade higher, but counteract losses when stocks pull back.

Comments

You must be logged in to post a comment.