The impact of COVID-19 on the global economy is unique, as it has not only affected demand like many crises of the past, but has also severely restricted cross-border supply chains. Sidiq Dawuda, Director of Credit Risk Solutions speaks about how global supply chains will be a critical factor that will weigh on the creditworthiness of some sectors.
The following questions have been addressed from our webinar hosted on July 01, 2020.
- 1) What impact has COVID-19 had on the default risk of industries?
The subset of industries within Consumer Discretionary are exhibiting the greatest increase in default risk/deterioration in credit quality, and the highest overall probability of default (PD). Investor concern that non-essential spending will be severely curtailed is a key driver of the heightened risk here.
Not surprisingly, auto manufacturers have demonstrated PDs that were higher than other industries, with a PD at the beginning of April 2020 that was more than 20% higher. This was partially due to a reduced supply of parts, production disruptions, slumping sales, and falling market optimism as a result of COVID-19. Consumer Electronics (a sector that excludes Personal Computing) also saw a steep rise in risk, and exhibited the second highest PD as of mid-June 2020, while Home Furnishings had the third highest PD.
- 2) Which indicators are best combined to highlight the majority of company defaults in a portfolio?
Using our statistical models and the historical default rates that we have seen with corporates, we can identify a clear relationship between observed defaults and our market- and fundamental-based indicators. We can see that the majority of company defaults in a portfolio occur when both market- and fundamental-based PDs present negative assessments. Both indicators are not always present for a company but, when they are, and indicate increasingly poor credit health for a company, careful attention should be given.
- 3) What are the critical factors when assessing supply chain exposures?
When assessing supply chain exposures, the initial credit strength of a company is a critical factor, especially as it enters into any economic crisis. Having a way to estimate the strength of a company incorporating data – such as company specific financials, market-based sentiment, default experience, and systemic metrics – will help give an indication of the entity’s ability to withstand COVID-19 related business pressures.
- 4) What is S&P Global Market Intelligence doing to help clients identify supply chain risks?
Identifying these supply chain risks may be challenging since counterparties may be unrated. Clients utilize S&P Global Market Intelligence Credit Analytics models, which incorporate stock price and asset volatility to calculate a one-year PD, capturing the more immediate market shocks from COVID-19. This helps assess the industries and companies that have experienced material changes to their default risk. In addition, our fundamentals-based CreditModel™ is used to gauge if the mid- to long-term credit risk of these companies has changed significantly. Finally, our RiskGauge Score takes on a hybrid approach, combining our fundamental-based models with market signals-based PD scores, thereby capturing the credit risk impact of COVID-19. This can be particularly significant since many private companies will only report financials once a year.
- 5) To what extent will companies show resilience and adaptability to the disruption caused by Covid 19?
As discussed during the webinar, we are seeing more resilience from Investment Grade companies when using our CreditModel in scenarios where cash flows and revenues are severely impacted, such as by events like COVID-19. Speculative Grade companies, on the other hand, are more likely to see a significant deterioration in creditworthiness.
- 6) What are some of the practical things you would suggest to a company wanting to make a resilient supply chain?
There are a number of things a firm can consider to create a more resilient supply chain:
- a) Map out your supply chain as comprehensively as possible to understand the broad extent of your direct and indirect exposure to other companies. Demand and supply shocks to another company could negatively impact your business operations.
- b) Measure the absolute and relative risk of companies in your supply chains to understand how strong or vulnerable these companies are, ideally using credit risk assessment models in order to evaluate a company’s ability to service its debt obligation.
- c) Start to build a list of back-up companies or alternatives within the supply chain that you may be able to switch to if necessary.
- d) Monitor the above on a frequent basis using early-warning signals, such as market-based indicators and more long-term credit indicators, so that you can respond quickly and make changes in a timely fashion.
As a Director within the Credit Risk Services team of S&P Global Market Intelligence in London, Sid's current responsibilities involve development of product strategy for Credit Analytics within the EMEA region. His role also encompasses thought leadership on Credit Analytics, primarily tailored to the EMEA investment banking, financial institutions, commercial lenders, and corporate segments.