To understand the extreme financial impact that COVID-19 has had on even healthy retail companies, consider Macy's. 

The department store giant stumbled into 2020, posting sales declines and unveiling yet another turnaround plan that called for store closures. Even so, in a disappointing year last year, it still made nearly $1 billion in operating income and carried modest leverage on its balance sheet.

March happened, and everything changed. Macy's closed all of its stores, and kept them closed for nearly two months, as COVID-19 spread through the U.S. At the outset, there were questions about whether Macy's had enough liquidity to get through a protracted crisis. The company reportedly hired the consultancy Lazard and law firm Kirkland & Ellis, both restructuring experts that ring bankruptcy alarms for investors and suppliers. For the first quarter, Macy's racked up a staggering $4 billion operating loss. 

Questions around the company's liquidity have been put to rest for now. Macy's drew $1.5 billion from its credit facility, nixed its shareholder dividend and raised $1.3 billion by issuing new bonds tied to some of its real estate assets. With COVID-19 still spreading, "Macy's, Inc. will be a smaller, more leveraged company for the foreseeable future," CEO Jeff Gennette said earlier in July.

Those moves saved Macy's, but they also altered it. "Their trajectory has been a concern, but they had a strong balance sheet," Dennis Cantalupo, CEO of Pulse Ratings, said of Macy's before the COVID-19 crisis. "They had plenty of unencumbered assets that they could tap into to bolster liquidity, which they did [i.e., during the closures]. That bought them some time, but it also eliminated some of the levers they could have pulled in the future. They were forced to use those cards now." 

Macy's is just one of dozens of retailers that have lost financial cushion since the pandemic began. "It comes back to the malls," Sarah Wyeth, sector lead for S&P Global's retail and restaurant coverage, said in an interview. Those retailers tied to enclosed malls, she added, "have the most to lose."

Wyeth noted that S&P's credit rating for Macy's has dropped four notches this year, standing today at B+, just a couple slots above the riskiest C-level ratings. Again, the department store is not alone. Ratings across the industry have dropped. Wyeth named a handful of mall-based retailers that have been downgraded and have lost financial ground since the closures began, including L Brands, Nordstrom and Gap Inc., along with Macy's.

Cantalupo also points to Kohl's and Nordstrom as having been forced to trade financial cushion for near-term survival, pledging unencumbered assets and taking on new debt to boost their liquidity. Bed Bath & Beyond, too, had time to work on its turnaround but also had to pledge new assets to wrangle a larger credit facility. "What is getting overlooked a lot is, what does that do to the capital structure?" Cantalupo said.

"There have been downgrades across the board because all this built-in financial cushion has been reduced," he added. "Macy's, Nordstrom and Kohl's — they're still a ways away from a potential bankruptcy, but … they don't have as much runway as they did." 

Rising risk

Along with credit ratings, a close look at financial metrics provides a window into who in retail has been made more vulnerable by the COVID-19 crisis. 

Analysis firm RapidRatings attempted to do just that by running a series of "stress tests" on companies in the industry, looking at how changes in revenue and other factors would impact the scores the firm created to assess financial health in both the short and medium term. The scores are based on more than 70 different financial ratios available publicly or provided privately. 

An initial stress test assumed a 15% revenue reduction across the board for all companies to see how metrics measuring their resilience and stability would hold up. A second test, done after more corporate results had come out relaying the precise affects of the COVID-19 crisis, used more industry and category-specific numbers around revenue, profitability, leverage and other factors. 

"Stress testing is an interesting way to do some scenario analysis of what-ifs," RapidRatings Chairman and CEO James Gellert said in an interview.  

Both sets of tests show how the COVID-19 crisis could affect retailers in both the short and the long term. In the second test, which assumes a nearly 20% decline in revenue for the department store sector, Nordstrom took one of the heaviest hits.

The score measuring Nordstrom's medium-term financial health — a 1 to 100 score that looks at performance and sustainability over the next two to three years — fell more than that of every other retailer except one. Overall the measure for Nordstrom, which RapidRatings dubs "Core Health Score," went from a "low risk" level today to a "high risk" after running the test.

Nordstrom is far from alone. Among those who suffered the steepest drops in health scores are stalwart retail names, including, yes, Macy's, which fell from a "medium" level of risk to "high" after the stress test. 

Others, including household names like Kohl's, Gap and Dick's Sporting Goods, ended the stress test with "medium" levels of risk, elevated from low current risk levels. 

​Burlington Stores, the off-price retailer, which shortly before the start of the pandemic began moving to exit its e-commerce business, saw the largest drop in its health score among all retailers. Because off-price retailers are so dependent on brick and mortar, they were deeply affected by the closures. But, as Wyeth and Cantalupo both noted, off-price retailers tend to do well in recessions and are well positioned even in a protracted economic downturn — as long as their stores can stay open. 

A 'messy recovery'

As the stress test shows, so much depends on to what extent sales remain deflated during the year, which is extremely difficult to predict in the current environment. 

Gellert, whose clients include both large retailers and their suppliers, said he's heard of large retailers remaining opaque about their buying plans, or dramatically shifting the expectations they set with suppliers. "It's pretty scary, there are these very large, relatively sophisticated stores that can't make accurate predictions," he said. 

If the market and the wider economy were to enjoy a so-called "V-shaped" recovery, with sales quickly rebounding to more or less normal levels after the closure period, that would bode better for the industry. But the spike in cases in populated states like California, Florida and Texas clouds and complicates the outlook for everyone. Moreover, government support for the unemployed and other stimulus measures are set to run out, though Congress is negotiating another round of stimulus. 

"It's hard to imagine with cases ticking up now, what recovery is going to look like," Wyeth said. "There's no this path or that path. It's a messy recovery. When the dust settles, there's going to be a consumer that's not as confident and is going to be wary about opening their wallets."

Stores can open, but will customers want to shop? Will public officials in hot-spot areas order stores to close again? All of this is incredibly difficult to predict. 

"We had been thinking about it in kind of all or nothing in terms of the geography of the country, instead of this slow, morphing from region to region" Wyeth said. "That complicates the recovery, and it complicates a forecast, because what's a first wave and what's a second wave?" She added, "At this point, I think it's reasonable to expect there will be additional temporary closures in regional hotspots." 

More closures would mean everything they did the first time: collapsed revenue, cash burn, revolver draws, negotiations with landlords and suppliers, and that much more financial cushion depleted. If those closures are limited, and the recovery creeps along, it could buy retailers time to build out and refine their digital operations, Wyeth notes. A second wave of mass closures — that's another story. 

"If there's another kind of wave of broader quarantine shutdowns, it would make it even harder for these companies in the worst part of retail," Wyeth said. "Mall-based apparel, some of the specialty retailers — they're going to suffer."