Assessing the impact of economic and financial shocks on SME credit quality: a scenario analysis

We estimate the impact of the Covid-19 pandemic on credit risk changes on a large sample of SME firms. The Altman Z”-Score model, which has proven to be a powerful and robust bankruptcy prediction model across many industries and countries, is used to assess over 1,000 SMEs from seven Polish industrial sectors. Specifically, we assess the vulnerability of the sampled firms to credit downgrades, including the likelihood of becoming insolvent and filing for bankruptcy, over the expected downturn in the real economy. Based on scenario analysis on individual firm financial data, we analyse rating transitions under multiple potential scenarios, focusing on the deterioration of the SME firms’ profits, and working capital including an increase in current liabilities. We find that the impact on companies from the various rating equivalent groupings are quite diverse and cannot be explained only by the firms’ industrial sector. Of particular importance is the proportion of firms whose credit quality deterioration could result in insolvency. What is perhaps surprising is that the most resilient companies with respect to credit downturns are, apart from the AAA/AA+ and AA/AA-rated, those which initially were assigned to the most risky (CCC) credit rating equivalent class. And, those that were assigned to lower investment grade classes were amongst the least resilient.