The ongoing coronavirus is extracting a heavy toll on financial markets and investors’ psychological well-being. Much of the focus of headlines has been on the gut-wrenching losses in major global stock and commodity markets, disorienting spikes in equity volatility and plunges in treasury yields. But the shaky foundations of the USD 72 trillion global corporate debt market arguably pose a greater threat to the economy and financial system, according to Josh Zwick, Partner at Oliver Wyman, and Alex Bernhardt, Director at Marsh & McLennan Advantage. Oliver Wyman and Marsh & McLennan Advantage are affiliates of Guy Carpenter.
Ever since the Global Financial Crisis (GFC) of 2007-09, global monetary policies have kept interest rates low, fueling a corporate debt binge that has resulted in a 60 percent increase in debt outstanding. Unlike the GFC, where the problems originated from an over-levered financial sector lending to over-levered real estate borrowers (facilitated by complex securitization), this crisis is originating in the real economy through a collapse in demand and isn’t confined to one sector.
The longer the global pandemic persists, the more likely underlying weaknesses of debt-laden corporate balance sheets will be exposed, setting off a wave of selling, impairments and defaults. In this scenario, a combination of mark-to-market losses and defaults will reduce investors’ appetite for corporate credit risk and will eat into financial institutions’ capital cushions, potentially destabilizing the system and constricting the flow of credit through the economy.