BY NEIL UNMACK

The pandemic has saddled companies in most of the world with debts. Big enterprises with reserves and access to capital now look like they can ride it out. Smaller outfits are at much greater risk of default.

Looking at the bond market, the coronavirus crisis was a short-lived affair. Lockdowns caused company revenue to collapse and debt levels to shoot up. The average leverage of U.S. junk-rated companies in the leisure sector, for example, doubled to around 12 times EBITDA in the six months to June, according to ING. Around that same time Moody’s Investors Service reckoned default rates globally could, in a pessimistic scenario, hit 16% in the coming year.

Some defaults came, including U.S. retailers Neiman Marcus and J.C. Penney. CreditSights analysts put the U.S. 12-month default rate in November at just over 7%. But the crunch eased thanks to bailouts, reopening economies, and companies raising fresh debt and equity. Federal Reserve Chair Jerome Powell and other central bankers slashed rates to zero and snapped up bonds, forcing investors to pile into riskier debt just to earn a return above inflation. The year 2020 has seen the second-biggest flow of funds into junk debt on record, Deutsche Bank analysts reckon. Their peers at Citigroup expect the U.S. high-yield default rate to fall back to just 3.4% in 2021, below 2019’s roughly 4% level, according to Moody’s.

Away from big-ticket capital markets, things are less rosy. Smaller companies typically have less diverse revenue and rely on banks for finance rather than bond investors. Even as high-yield borrowers pay less in interest, the proportion of U.S. banks tightening credit standards is near its highest level since 2009, according to the Federal Reserve Senior Loan Officer survey. Around a tenth of small and medium-sized companies across Europe may collapse in the next six months, McKinsey said in a November report.

Governments have helped by granting companies tax relief and guaranteeing debt. But in the UK, for instance, as much as 23 billion pounds of a potential 74 billion pounds of state-backed debt may be unsustainable, according to a report by CityUK.

The small-company crisis matters. Bigger, more financially robust groups may simply crowd out struggling competitors. Starbucks, for example, is among other moves raising wages, potentially making life even tougher for rival local coffee shops. To avoid continuing attrition, governments may need to extend cheap debt programs for longer or even forgive loans. Another option might be offering tax breaks to spur investment. With government debt also ballooning, that may require tough fiscal choices in 2021 and beyond.

First published December 2020