The US Ten-Year Economic Expansion is in the Balance
The United States is in the midst of an economic expansion (currently clocking in at 10 years and 9 months) - the longest in recorded history, according to data from the National Bureau of Economic Research. Prolonged expansions are not unprecedented; the US last experienced a 10-year expansion leading up to the “dotcom” recession that began in 2001.
Fortunately, financial regulators have put safeguards in place to ensure that the same controllable impacts that drove the 2008 mortgage crisis do not rear its ugly head again during the current expansion. Over the years, some regulatory relief from the Dodd-Frank Act has been given to both small and large banks. For example, small banks were granted loosened regulatory requirements that made it easier for them to comply.
Reacting to the Economic Impact of Coronavirus
Business leaders and economists have been debating the timing of the next recession and its most likely triggers. Unfortunately, no one could predict nor preemptively prepare for the destructive capacity of Coronavirus (COVID-19). Exogenous impacts such as epidemic and pandemic crises are difficult to control. The central bank of Italy, the US Federal Reserve and Bank of England were quick to take action against Coronavirus by lowering short-term interest rates. The US and UK half-percentage point rate cut speaks volumes to the seriousness of the situation. Impacted countries globally are considering an array of policy measures including guaranteeing business loans, salary subsidies (to avoid layoffs), payroll-tax cuts and sick leave expansion to cushion the economy from the impacts of the epidemic. Regardless of the intended economic stimulus, on March 9, 2020, the Dow Jones dropped by 7.8%, a total of 2,014 points, the largest decline since the 2008 financial crisis, followed by the biggest Dow Jones selloff since 1987 during the week of March 13.
Correlation Between Recessions and Bankruptcies
Dun & Bradstreet is tracking these developments in the world economy very closely. Our analysis shows that the past two recessions, in 2001 and 2008, have been accompanied by precipitous increases in bankruptcies (refer to the chart below). The trend is very clear in both the dotcom recession of 2001 and what is often termed the Great Recession of 2008.
During the Great Recession, business bankruptcies in the US spiked by 35% to 40% for more than two years just before and trailing through the recession. During that time Dun & Bradstreet reported a total of 101,000 bankruptcies over the two-year period. This bankruptcy velocity was two to three times higher than the average yearly bankruptcies reported during economic expansion period of 2010 to 2019.
Dow Jones Performance and Bankruptcies Diverge During Recessions
[Source: Dun & Bradstreet]
Central banks are taking strong actions to counter the impact of Coronavirus. These precautions could help financially secure companies that require a short-term liquidity solution, but, as we saw in 2008, companies in a weak financial state are at an increased risk of failure and could get weeded out. Given 10+ years of expansionary business creation and low bankruptcy rates, we are concerned that an economic downturn could result in unprecedented number of bankruptcies.
How to Prepare for Potential Impacts to Global Business Credit
I’m advising my finance and credit clients to re-evaluate their company's credit policies to ensure they are:
- Onboarding an Appropriate Balance of Risk – A prolonged period of economic prosperity and minimal bankruptcies may have influenced the day-to-day credit policy approach, allowing more risk into the portfolio than would be prudent in a slow growth or recessionary economy. Reassess your company’s credit policy to recalibrate the portfolio risk profile for new and existing customers.
- Setting Proper Credit Limits – Use this opportunity to realign credit limits. Make sure they are informed by the credit exposure you have for the entire global corporate hierarchy for that customer. Consider adjusting credit limits (up and down) based on the individual risk assessment of that customer.
- Establishing Appropriate Terms – Evaluating the potential risk of each new opportunity or customer renewal will help realign your credit terms based on the probability the customer will pay on time and within terms.
- Monitoring Portfolio Risk – Perhaps more urgently, I advise to also consider deploying credit risk monitoring of the entire global portfolio to pick up on pockets of weakness that could result bad debt losses from potential bankruptcies.
There are opportunities in every economic situation. Many companies may need to quickly acknowledge that while bad debt losses have been muted over the past 10 years, we may be entering into a new economic reality which requires a more active approach to credit risk mitigation.
Let Dun & Bradstreet help you understand the hidden risk in your customer portfolio through the D&B Customer Risk Health Scan. This complimentary report identifies which of your customers are located in an area affected by Coronavirus.
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