New Markets, New Models:

Credit and Liquidity Consequences of COVID-led Acceleration of Industry Reform

By Wouter Lips

Before the COVID-19 pandemic, financial analysts were already predicting a recession. From a bond market bubble to shrinking economic growth in nine major countries, warning signals were being sounded. New Markets, New Models: Aligning Credit and Liquidity Risk Management to New Market Realities, a Periculum publication, discussed these threats amid transformation in industries which have experienced a shift of power from West to East, new market entrants, the technology revolution, and changes in environmental and social behaviors.

Then COVID-19 shut down the world which triggered a global recession. This changed the nine major countries who were experiencing downturn to 170 countries that were realising lower per capita income than at the start of the year. Customers were unable to visit shops and buy products. Companies were unable to produce and supply goods. Workers were unable to work due to lockdown measures. The result of this: the creation of both a supply- and demand-side shock.

Market uncertainties amid stimulus packages

Consequently, central banks around the world have taken unprecedented action, including additional interest rate cuts (despite the interest rates already hovering around zero), significant liquidity injections and reinforced quantitative easing. In order to stabilise their respective economies, the response to this crisis has been worth around $10 trillion, including one-third from the EU and $2.3 trillion from the U.S., and more is expected.

These stimulus packages will have unknown consequences which gives rise to considerable uncertainty and speculation. For example, one situation that may occur is a divergence between what is happening in financial markets compared to what is actually happening in the real economy. This is already evident in the market with the S&P 500 almost back to its record-high, rising 20%, it’s best quarter since 1998, despite the economy being at a standstill for a quarter.

The incredible “reversal of fortune” could potentially be explained by investor sentiment, which has fluctuated during the pandemic and lockdown based on good and bad news. Stocks rose during increased stimulus and easing of the lockdown, and they fell when the lockdown was reversed and stimulus waned. The disconnection in the financial markets is partly attributable to the large liquidity injection coming from stimulus packages, thus it is unclear how the markets will stabilise in the future.

Additionally, concerns around bankruptcies and unemployment levels are creating more timid investing behaviors. Coming out of the crisis, many firms will have increased balance sheets through debt taken on during the recession. More bankruptcies and higher structural unemployment levels are very likely in the near future. Edward Altman, the Max L. Heine professor of finance, emeritus, at New York University’s Stern School of Business, estimated that in 2020 we will see a “record for so-called mega bankruptcies [66 of them] – filings by companies with $1 billion or more in debt.”

He further expects around 192 bankruptcies involving at least $100 million in debt. Though it is difficult to identify the direction of the economy and credit markets, given the fact many companies required access to additional credit to avoid bankruptcy, companies may find their already vulnerable revenue is impacted by greater financial obligations. More significant may be the financial damage taken by banks as a result of loan losses. To combat this, Wall Street banks have set aside $25 billion to absorb the losses.

The toll of prolonged unemployment

A line of shadows of people lined up against a brick wall standing in a queue for unemployment benefits.

Added to the threat of financial failure for companies is the toll a prolonged phase of high unemployment has on spending habits. Prolonged unemployment is expected due to the reduction in economic output. Economic activity is expected to fall 6% in 2020, with U.S. unemployment reaching a staggering 14.7% during the pandemic. And according to forecasts of the OECD, unemployment will climb to 9.2% from 5.4% in 2019. This will decline somewhat as economies reopen, but it will take multiple years for the economy to fully recover, and the structural unemployment may increase as accelerated change in business models in certain industries, such as the automotive industry, renders a number of skills out of demand.

In addition, given the significant increase in unemployment globally, consumer loan losses are likely to increase throughout the year. It’s important to note, however, that consumer loan defaults in the COVID-triggered recession may include a lagging effect which is caused by the role of government schemes in propping up the economy and keeping consumers liquid. The lagging effect means that some stress indicators may not show the impact of this until the fourth quarter of 2020 or the first quarter of 2021.

Given these compounding situations, the impact of the COVID-triggered recession will lead to uncertainty in investing and in making future investments in setting the business strategy. Simultaneously, credit underwriting will be more difficult due to deteriorating fundamentals (e.g. revenue decreases, financial obligations increase, etc.) and changes in spending. Complications in credit underwriting will impact consumers through lending facilities for those consumers who have been furloughed or on mortgage holidays. This impact will extend also to companies that have taken additional debt burdens in the hopes of a V-shaped recovery.

The combination of all these factors will cast a cloud of uncertainty in the economy for both companies and investors. Governments will need to provide significant levels of support to pull their respective economies out of a slump. The current situation is especially problematic for industries at the forefront of business model changes, and they may soon find themselves in a make-or-break position. However, opportunities, such as those in the case study below, are also available in designing a stronger framework for moving forward.

Case Study: The credit and liquidity impact on the automotive industry

Current environment

One of the industries hit hardest by the pandemic, the automotive industry saw year-on-year sales fall 40.4% (private sales) and 47.4% (fleet sales), partly resulting in a loss of over $100 billion across the sector. One estimate suggests one in six jobs in the UK may be erased due to this loss.

The current environment in the automotive industry is creating a “toxic cocktail” for carmakers led by:

  • Manufacturers inability to reach maximum capacity because of disrupted supply chains and health restrictions.
  • Consumer fears of unemployment and income cuts.

Further, a hard Brexit could lead to volumes falling to levels not seen since 1953, meaning a cut of £40 billion in revenue on top of the £33.5 billion worth of production losses from COVID-19. The Society of Motor Manufacturers & Traders does not expect output to recover to pre-recession levels until 2025, and this is contingent upon a trade deal between the UK and Europe. COVID-19 requires companies to adapt to an enrichment of data relating to new, emerging risks that needs to be captured and used to construct models for forecasting credit and liquidity risks in a rapid-changing situation such as COVID-19, whilst simultaneously managing significant geopolitical and social risks, to minimise the damage done to the company.

In Germany, where the threat of a downturn was already looming, thousands of jobs both within the industry and along the supply chain are in danger. Additionally, the German car market has seen year-on-year falls in January of 7.3% (2020) and 10.8% (2019) respectively. There are three primary expectations for financial impact (possible harm) and moving forward (opportunities) for the automotive industry: accelerated business model changes, vulnerable supply-side shocks, financial consequences affecting liquidity.

Accelerated business changes
Power supply for hybrid electric car charging battery. Eco car concept.
  1. A unique chance towards low carbon and climate resilient growth led by:
  • Increased pressure from industry stakeholders to make the change to electric vehicles. The new electric vehicle market is growing at a fast pace and requires car manufactures to adapt new models to remain competitive. The share of electric vehicle sales is expected to be 2.7% in 2020, 28% in 2030 and 58% in 2040.
  • Governments providing liquidity or credit with special electric vehicle covenants.
  • Government bailouts and lending schemes being offered contingent on the company meeting environmental targets such as:
    • The Spanish government unveiled a €3.75 billion aid package for the domestic auto industry which includes a scrappage scheme with green strings, a bigger focus on electric charging points and funding for hydrogen power.

2. Online dealership experience

  • Some manufacturers are focusing on the online dealership experience which was previously unsuccessful in the marketplace.
  • Carvana, the used car dealership that does everything online (the car can be shipped to you or you can pick it up at their “car vending machine”) has shown revenues that are doubling every quarter.
Vulnerable to supply-side shock

The pandemic broke the supply chain as production hubs were shut down by lockdowns that disrupted key links in the chain. Contingency plans designed to mitigate supply chain interruptions were not prepared for global quarantine and travel restrictions, something that should be considered in risk management frameworks in the future. The following impacts may occur:

  • Widespread consequences for the global supply chain as some companies look to diversify away from one major hub.
  • De-globalisation of supply chains as companies look to produce locally to mitigate the risk.
  • Heightened geopolitical risks with China being at the center of both supply chains and the pandemic.
  • The interruption will trap cash that could have been deployed, thus restricting the liquidity flexibility of companies in a time in which that flexibility is valuable. As the cash will be illiquid for a while, it could be used as collateral to access capital now and seize opportunities in return for the strapped cash in the future.
Financial consequences affecting credit and liquidity

The recoverability of receivables from both consumers and other companies could affect a company’s liquidity position negatively.

Being flexible with debtors may be the best way to get capital and create goodwill. Collaboration with extended business partners will create trust and creating special offers or protective measures for customers in financial hardship, such as Ford’s promise to allow customers to return their new cars if they lose their jobs, will be remembered for future buying.

Cash used to invest in the transition to a new business model is now being used to absorb the blows from the pandemic (a concern highlighted in New Markets, New Models about flexibility to continue taking strategic opportunities while managing crisis). As a result, the capital that was accessed through various methods (debt, investments) will not now show a return on investment as the capital is deployed in a different manner. This may affect the company’s credit position as it will be harder to provide potential lenders with either collateral or new business plans. Thus, access to credit will be tougher and potentially more expensive.

  • An example of this is in Volkswagen who aims to reduce its material overheads by 20% and has cancelled plans to build a manufacturing plant in Turkey as their net liquidity continues to fall and the pandemic slows the auto market.

Car companies with a strong balance sheet and access to capital can assess and react to customer preferences – including those associated with the green movement – if they deploy their cash for M&A, particularly to purchase companies at a “pandemic-induced discount.”

COVID-19 has shown the importance of supply chain visibility and well-defined lines of communication as well as the need for new credit and liquidity models that provide insights based on the new COVID-19 environment. It has also shown the significant struggle companies may have in adjusting their business model to new markets, especially in a time where new risks emerge and old risks get stronger. Improving these will help companies detect potential issues early, allowing them to navigate the recession proactively rather than reactively.

If your business needs assistance determining the credit and liquidity risks you’re facing during and after COVID, book a call with one of our risk practitioners today or email our Risk Manager, Credit and Liquidity, Wouter at

Wouter has completed an MSc in Finance at UCL. He has gained in-depth experience in financial planning and modelling, from Oil & Gas to Investment Management industries. Insights