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Tuesday, April 7, 2020

What will the companies do with the credit rating firms’ face-off and their consequences?

Many companies have stopped or reduced their dividend payouts and terminated their share buybacks to conserve cash to avoid credit rating downgrades.

However, these actions will cause their share prices to drop due to the diminishing purchases of their companies’ stocks, as there are no incentives to buy them anymore.  Consequently, this will prompt the state wealth funds to sell the stocks of these companies to conserve their cash for future value purchases or redirect their cash for their own economic developments.

The current financial crisis flowchart is as follow:

Corporate debt -----> Company's credit rating -----> Company share price

First of all, the corporate debt will spark off a financial crisis which will affect the company's credit rating.  Therefore, the company has to conserve cash in case it has to redeem its corporate debt.  The debt redemption will cause the share price to fall as investors want the company to put its cash in a growth sector and not to repay its debt.  A shale oil producer will be an excellent example to depict this.

Many shale oil producers have to raise funds continuously to purchase equipment and chemicals to do oil extractions and these corporate debts are usually repackaged into high yield debts (junk bonds).  When the junk bonds market starts to crumble due to the low oil prices, these shale oil producers will have to terminate their dividends and share buybacks to conserve their cash to avoid credit rating downgrades.  Without these incentives to support the share purchases, their stock prices will start to fall because the investors will bailout.

The US FED has managed to stop this hemorrhage temporarily by declaring to buy any debt including junk bond and this has caused the US FED to accumulate US$5.3T assets insofar.


Eric Ho said...

The oil and gas industry has about US$5T debts and I don't think the US FED can buy all these debts to save the oil and gas sector.

Eric Ho said...