Energy, Hospitality Sectors At Greatest Risk Of Cash Crunch From Pandemic, NY Fed Says

Companies in the U.S. oil-mining and entertainment-food-hospitality sectors are likely to face the biggest credit crunches as a decline in cash flow caused by the COVID-19 pandemic led to rising debt levels.

The Federal Reserve Bank of New York warned that a “sizable share” of U.S. publicly listed groups in these industries now face a potentially serious credit crunch.

A report written by New York Fed economists led by Anna Kovner, vice president in its research and statistics group, found that the pandemic had a “negative impact on cash flow while also reducing corporations’ interest expenses. However, the cash flow shock far outpaced the benefits of lower interest payments, especially in industries that were disproportionately levered.”

Looking ahead, the New York Fed warned that as a sizable portion of U.S. corporations have interest expense which exceed their cash flow, this raises concerns about “the ability of those corporations to endure further liquidity shocks.”

Looking at earnings before interest, taxes, depreciation, and amortization, or EBITDA, as a proxy for cash flows, the report indicated that aggregate cash flow for all publicly listed companies declined by about 22% from the first quarter of 2019 to the first quarter of 2020.

The impact on cash flow varied widely, the New York Fed found, with the mining-oil and entertainment-hospitality-food sectors suffering the biggest declines in cash flow.

Within mining-oil, EBITDA plummeted 176% from the first quarter of 2019 to the first quarter of 2020, while for entertainment-hospitality-food, EBITDA fell by around 41%.

“In the least affected industries, such as utilities, the median EBITDA either fell by just a few percent or increased,” the New York Fed stated.

There was also significant heterogeneity within industries. For example, in the retail sector, auto accessory retailers saw a large decline in cash flows due to “lower use of automobiles by consumers subject to stay-at-home orders, while grocery stores saw increases in their revenues.”

The New York Fed explained that during an economic downturn, highly levered companies are at “greater risk of becoming insolvent” than less-levered firms since “they must continue to make interest payments on their debt even when their business may have slowed.”

In addition, if a company’s cash flow falls below its interest expense, it may “default on its debt if it is not able to borrow additional money to cover those interest expenses” the economists said.

By measuring interest coverage ratio, or ICR -- a company’s EBITDA divided by its interest expense – the New York Fed looked at which industries were most vulnerable to financial difficulties and rat risk for default. The New York Fed defined a company at risk of becoming delinquent and its debt being at risk of default if its ICR was less than 1.

“With restrictions on travel and restaurant dining in place across the United States, the entertainment-hospitality-food industry has been disproportionately affected by the COVID-19 outbreak,” the New York Fed wrote.

This industry witnessed one of the highest increases in the share of companies with ICR below 1 -- with 36.7% of public firms in the sector at risk of becoming delinquent in the first quarter of 2020, up from 12.9% in fourth quarter of 2019.

Companies in the mining-oil sector are also at high risk. In the fourth quarter of 2019, about 27% of companies in this sector had an ICR less than 1 – that figure jumped to 33% in in first quarter of 2020.

“The increase… can partially be attributed to the sharp decline in oil prices in the beginning of March, which was the result of a global price war as well as falling demand for oil during the pandemic,” the New York Fed explained.

Peering ahead into the near future, the New York Fed predicts that earnings in the remaining quarters of 2020 will “depend primarily on the dynamics of the economy which, in turn, depend on the evolution of the pandemic.”

The New York Fed thinks there is likely to be “wide variation across industries” in how the future cash flows of firms are affected by the COVID-19 outbreak.

“Since the most affected industries during the first quarter were also those with relatively greater leverage before the start of the pandemic, there is heightened concern about the delinquency risk in these sectors,” the New York Fed added.