Paper Spotlight: The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of COVID

Sascha Steffen

Viral V. Acharya

Governments all over the world have responded to the COVID-19 outbreak by closing down significant parts of their economies, leading to a liquidity crisis for many firms. Default risk increased because firms’ stream of cash flows took a hit, and with it firms’ rollover risk. How did firms behave in their bid to shore up their precarious liquidity positions? In the paper “The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of COVID,” Viral Acharya and Sascha Steffen use a novel dataset of daily credit line drawdowns at the firm-loan-level and find evidence consistent with a “dash for cash” of BBB-rated firms. This was particularly true of firms that had similar credit quality to non-investment-grade rated ones. The risk of becoming a fallen angel, i.e. losing investment grade status, played a very significant role. These firms managed to convert committed credit lines into cash which, in turn, placed pressure on banks’ balance sheets. While these results show that banks’ financial health improved markedly in the decade after the 2008 financial crisis, they also shed light on the pressure brought to bear on banks from the accelerated drawdowns of credit lines and provisions for possible future credit losses. There is an important message from the paper: Regulators should keep a very close eye on banks’ financial health and either require or nudge them to do everything possible to conserve capital by, for example, withholding dividend payments or stopping share repurchases.

Spotlight by Andrew Ellul
Photos courtesy of Viral V. Acharya and Sascha Steffen

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