Bankruptcy veteran Dr. Edward Altman sees trouble brewing in corporate credit, with mass ratings downgrades and company bankruptcies on the horizon as the coronavirus outbreak shakes the global economy.
Altman, who is a professor emeritus at NYU Stern School of Business added that even before the virus, the fundamentals of companies and markets were already showing “a lot of warning signs.”
A growing number of analysts predict the market’s mass selling of risk-sensitive assets will eventually hammer the corporate debt sector, where companies — some with weak balance sheets — have feasted on cheap credit.
“I think the chances of a recession have spiked dramatically, obviously, since the coronavirus threat and now impact has happened,” Altman told Yahoo Finance, pointing out that the average economist is now forecasting “around a 60% chance of a recession” within the next 12 months, up dramatically from before the outbreak.
That means a lot of companies kept afloat by cheap borrowing costs could be in real trouble. Altman contended that many of them should actually go bankrupt, because “they are zombies and have been kept alive” by historically low rates.
Recently, Moody’s Investors Service forecasted that issuer default rates could rise by the end of this year, and the coronavirus outbreak could make it even worse. Speculative-grade debt, otherwise known as junk bonds, is likely to be hardest hit.
Altman — who pioneered the financial-distress sniffing ‘Z-Score’, a formula he created more than 50 years ago for predicting bankruptcies — suggested ratings agencies are often slow to recognize when companies need to get downgraded.
“We ran a Z-Score test on BBB companies in the United States year-end 2019. And, in a downturn, a big downturn which happened in ’08 and 2002 etcetera, maybe 10% the rating agencies say get downgraded,” he said.
“That’s a very important thing — downgraded to high yield. If that happens, then you have problems in that market depending on the amount,” he said — adding that his model suggests the situation could be far worse than that 10% figure.
“We ran our tests looking objectively at the health of BBB companies at the end of 2019 when everything was going great, and we came up with more than 30% looked vulnerable to a downgrade, in fact, looked like non-investment grade companies even then,” Altman told Yahoo Finance.
“And that’s going to happen, maybe not 30%, because we don’t do the rating change. But it does happen, and when that happens, a lot of marginal companies are going to be forced out of business,” he added.
Julia La Roche is a Correspondent at Yahoo Finance. Follow her on Twitter.