The coronavirus pandemic is having a leveraging effect on North American corporates due to reduced cash flow and increased debt issuance to shore up liquidity during the outbreak, says Fitch Ratings:
"Under our baseline scenario deleveraging to pre-coronavirus levels could take at least two years, given median forecasts of approximately 70 issuers with credit profiles identified as most at risk. These issuers, which Fitch classified as ‘Category A’ and prioritized for review in March, operate in sectors with high coronavirus exposure, had limited ratings headroom at the start of the crisis, or were subject to fallen angel risk given ratings in the ‘BBB’ category."
Median lease-adjusted debt/EBITDAR for these issuers is projected to rise to 5.2x in 2020, from 4.4x in 2019, and then decline to 4.8x in 2021, with a varying pace of recovery across sectors. Fitch downgraded issuers forecasted to be outside of leverage thresholds at YE 2021 and/or revised their Rating Outlook to Negative or placed them on Rating Watch Negative.
Our baseline coronavirus scenario assumes most at risk sectors experience a very sharp contraction in second-quarter 2020 and third-quarter 2020 and see improvement, but not entirely back to pre-crisis levels, immediately after lockdowns are lifted. Other sectors will experience a slower recovery due to high unemployment, supply chain disruption or the effects of social distancing.
Key assumptions in Fitch's rating case for rated airlines, for example, include a steep drop in demand through 2020, with full recovery potentially not occurring until 2023. Median lease-adjusted leverage for the North American airlines prioritized for review earlier this year is projected to approximate 4.3x in 2021, still above the median leverage of 2.5x in 2019. Fitch took negative rating actions across the sector which resulted in eight rating downgrades. Delta Airlines and Alaska Airlines, previously rated in the ‘BBB’ category, were downgraded to sub-investment grade.
Conversely, median lease-adjusted leverage for the ‘Category A’ energy companies is projected to return to the 2019 pre-coronavirus level of roughly 5.5x by 2021. Sharply lower oil prices, which have recovered toward Fitch’s previously revised based case, caused by the coronavirus-driven demand destruction and high supply, resulted in significant credit risk for energy companies. Fitch took negative rating actions on many issuers earlier this year after lowering base case price assumptions. Several energy companies were downgraded to sub-investment grade.
We anticipate deleveraging will be driven by a combination of EBITDA growth, as revenue trends improve and issuers benefit from cost reductions, and debt repayment as some companies repay debt taken on during the crisis by YE 2021 or 2022, when it is callable. Companies across nearly every sector drew on revolvers in March, a period corresponding to more US states implementing shelter-in-place orders, to increase cash-based liquidity.
Many investment-grade issuers opportunistically issued bonds after tapping revolvers as a flight to quality stemming from the economic fallout of the coronavirus and Federal Reserve backstop programs lifted demand. Some issuers used proceeds to term out revolver borrowings, repay CP or refinance upcoming maturities. Expedia and Marriott, for example, were ‘Category A’ issuers that drew on revolvers and subsequently issued bonds.
Debt for the ‘Category A’ issuers is projected to increase nearly 10% in 2020. We forecast debt to only be up 2% over 2019 in 2021. Total EBITDA for this group is projected to decline over 45% during 2020, assuming economic conditions do not deteriorate beyond our baseline scenario toward our downside case. We then expect EBITDA to recover to more than 90% of 2019 levels in 2021 for these issuers.
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