Chart 1

Credit quality among corporations rated by S&P Global Ratings in the U.S. (including the tax havens Bermuda and the Cayman Islands) deteriorated in the fourth quarter of 2019. The number of defaults rose to 20 in the quarter, contributing to a 64% increase for full-year 2019. Downgrades rose for a fifth consecutive quarter (to 133), and declining upgrades brought the downgrade ratio (downgrades as a share of rating actions) to its highest since 2016 (at 77%). The potential for future downgrades also increased slightly in the quarter as the negative bias (the percentage of issuer credit ratings with negative outlooks or on CreditWatch with negative implications) rose by 1 percentage point to 20%.

Most Fourth-Quarter Credit Deterioration Was Limited To Companies In The Lowest Rating Categories

While these trends indicated weakening credit quality, this weakness is highly concentrated among the lowest ratings. About 41% of issuers with negative bias (that is, with negative rating outlooks or ratings on CreditWatch negative) and 40% of the issuers downgraded in the quarter were rated 'B-' or lower, and more than two-thirds of issuers downgraded in the fourth quarter or with negative bias were rated in the 'B' or 'CCC'/'C' categories (see charts 1 and 2). Meanwhile, upgrades were less concentrated and were led by the 'BBB' category.

The number of U.S. corporate issuers rated in the 'B' or 'CCC'/'C' categories is at an all-time high, accounting for nearly 40% of U.S. corporate ratings, while issuers rated 'B-' or lower account for 17%. Issuers at these ratings tend to show higher default risk and less rating stability than higher-rated issuers.

Chart 2

Downgrades of issuers rated 'B-' or lower have generally been trending higher as a proportion of downgrades since bottoming out in 2014 (see chart 3). The 'CCC'/'C' category experienced the most downgrades in the fourth quarter and reached its highest quarterly total since the second quarter of 2016.

Chart 3

The speculative-grade (rated 'BB+' or lower) negative bias increased in the fourth quarter, exclusively from an increase among issuers rated in the 'B' and 'CCC'/'C' categories. The number of these companies with negative bias rose by 26 during fourth-quarter 2019, with the largest increase coming from issuers rated 'B-'. Meanwhile, the number of companies with negative bias from all rating categories above 'B' fell by five (see chart 4).

Chart 4

Negative Bias Continues To Climb For Speculative Grade, Remains Steady For Investment Grade

The negative bias for speculative-grade companies increased by 2 percentage points to 23% in the fourth quarter, and investment-grade (rated 'BBB-' or higher) negative bias remained steady at 12%. The positive bias (the percentage of ratings with positive outlooks or on CreditWatch with positive implications) remained unchanged for speculative-grade companies, at 6%, but decreased slightly, to 3%, for investment-grade companies (see charts 5 and 6). During full-year 2019, the positive biases for investment-grade and speculative-grade companies each fell by 2 percentage points.

Chart 5

Chart 6

Negative Bias Rising Across Sectors

The increase in negative bias in the fourth quarter was dispersed across sectors. Negative bias increased in nine sectors, while it fell by more than 1 percentage point in just two sectors (see chart 7).

Chart 7

The oil and gas sector experienced the largest quarterly increase in negative bias, up by 7 percentage points, and the sector's negative bias climbed by 13% for full-year 2019 as companies coped with volatile energy prices, liquidity issues, and high leverage.

Several exploration and production (E&P) companies, especially those with large natural gas exposure, face expiring credit facilities and debt maturities, and with less favorable financing available, liquidity issues are common. Meanwhile, as E&P companies have cut back on capital expenditure, this has contributed to reduced demand for oilfield services, even as efficiency gains have reduced the need for equipment and services. Given these challenges, capital market access has been unfavorable for this sector. This is especially true for lower-rated speculative-grade issuers, among which distressed exchanges have been more common.

For full-year 2019, the auto sector had the steepest increase in negative bias, up by 18 percentage points to 30%. After earlier increases, the sector's negative bias fell by nearly 1 percentage point in the fourth quarter after the outlooks on several companies were revised to stable following downgrades. These companies included Ford Motor Co. and The Goodyear Tire & Rubber Co.

Headwinds remain for the sector. S&P Global Ratings expects U.S. light-vehicle sales to decline by nearly 3% to 16.4 million units in 2020, before stabilizing at about 16.3 million units in 2021 and 2022. In the U.S., automaker profits will remain highly dependent on the truck segment (CUVs, SUVs, and pickups), which will continue to dominate the market.

The metals, mining, and steel sector also showed a notable increase in negative bias in the fourth quarter, up by 4 percentage points to 19% after United States Steel Corp. and Cleveland-Cliffs Inc. announced acquisitions.

While negative bias rose in most U.S. sectors in the fourth quarter, a couple of sectors were notable exceptions. The negative bias in the transportation sector decreased by 5 percentage points to 6% (see chart 8) after several speculative-grade rating outlooks were revised to stable following downgrades.

The retail and restaurants sector, meanwhile, has the third-highest negative bias, at 29%, yet the sector's negative bias declined by just 1 percentage point from the end of 2018 as the industry continued to face headwinds from changing consumer shopping habits.

Chart 8

A Growing Share Of Sectors Show Above-Average Negative Bias

One way we examine downgrade propensity is by comparing the current negative bias with the historical average. Currently, the eight sectors with above-average downgrade potential are oil and gas, aerospace and defense, autos, telecommunications, health care, retail and restaurants, consumer products, and chemicals, packaging, and environmental services (see chart 9).

At the end of 2018, just three sectors had negative biases above their long-term averages. But downgrade potential has spread broadly across sectors as economic growth has moderated and as lower-rated companies have proliferated across sectors (see chart 10).

Chart 9

Chart 10

We use a similar approach to gauge upgrade potential, comparing the current positive bias of a sector with its long-term average (see chart 11). Two sectors, metals, mining, and steel and the homebuilders and real estate sector, are showing high upgrade potential compared to their historical averages, but for metals, this appears to be a matter of timing, while for homebuilders, it portends improved credit quality sectorwide.

The upgrade potential among metals issuers will likely not persist, because our positive outlooks are linked to a few corporate actions, like changes in financial policy or mergers and acquisitions, that will run their course over the next few quarters. In fact, the sector's net bias (the positive bias minus the negative bias) abruptly turned negative in 2019 amid weaker profits and higher capital outlays; we downgraded seven issuers in fourth-quarter 2019 and upgraded only one.

In contrast, U.S. homebuilders have benefited from a decade of slow, steady growth in the housing market, and numerous issuers are reducing debt or building cash as the cycle advances. We see several issuers building their credit cushion ahead of a potential downturn.

Chart 11

The U.S. Corporate Downgrade Ratio Continues To Trend Higher

Downgrades are contributing a growing share of rating actions. The downgrade ratio (the share of rating actions that were downgrades) for U.S. corporate entities rose nearly 4 percentage points to 77% in the fourth quarter (see chart 12).

Chart 12

While the uptick in downgrades and the downgrade ratio appears to mirror pre-recession trends from 2001 and 2007, the current increase is also comparable to the period in late 2015 and early 2016, which ultimately didn't precede a U.S. recession. The collapse in oil prices and a slowdown in the Chinese economy led to pronounced credit stress in the energy and natural resources industry during that period, but this stress did not ultimately spill over into other industries, and economic expansion was undeterred.

Although credit weakness is currently spread more broadly than it was in late 2015, S&P Global economists project that the odds of a U.S. recession have fallen to 25%-30% (from the prior assessment of 30%-35% in August). They project GDP growth will slow yet remain positive at 1.9% in 2020 (down from a 2.3% forecast for 2019) as resilient U.S. consumers continue to support economic growth.

The number of downgrades rose to 133 in the fourth quarter from 119 in the third, while upgrades declined to 39 from 43. The amount of debt affected by downgrades, up 32% to $437.7 billion, was three times the amount of upgraded debt, which also rose in the quarter, up 49% to $143.5 billion (see table 1). The downgrades of a few investment-grade companies (including Ford Motor Co., Amgen Inc., and Boeing Co.) accounted for nearly 38% of the debt affected by downgrades in the quarter.

Table 1

Nonfinancial downgrades led the increase, rising to 130 from 117, while financial services downgrades rose to three from two. Nonfinancial upgrades fell to 32 from 39, while financial services upgrades rose to seven from four (see chart 13).

Chart 13

While both investment- and speculative-grade downgrades increased in the quarter, the vast majority of downgrades were from speculative-grade issuers. The number of speculative-grade downgrades rose by 8% in the fourth quarter to 116, and 53 of these downgrades were of issuers rated 'B-' or lower.

As the pace of downgrades has picked up, we've also witnessed fewer upgrades. Upgrades have now fallen in three consecutive quarters. The number of investment-grade upgrades fell to 15 in the fourth quarter from 21 in the third, though speculative-grade upgrades partly offset this with an increase to 24 from 22 (see charts 14 and 15).

Chart 14

Chart 15

Media And Entertainment And Consumer Products Led Downgrades

The media and entertainment sector had the highest number of U.S. corporate downgrades in the fourth quarter, with 20, up from 14 in the previous quarter. All but one of the downgrades were speculative grade. Two speculative-grade companies were upgraded in the sector (see chart 16).

Downgrades also remained elevated in the consumer products sector, which had the second-highest tally, at 17, down from 18 in the previous quarter. One downgrade was of an investment-grade issuer, and there were no upgrades in the sector.

The utilities sector continued to lead upgrades, with 11 in the fourth quarter. Most of these upgrades followed the conclusion of a criteria review that commenced after the publication of the revised "Group Rating Methodology" criteria on July 1, 2019.

Within speculative grade, high technology led upgrades with five in the fourth quarter. Most of these upgrades followed companies improving their financial metrics, including through debt paydowns, a refinancing, and an IPO.

Chart 16

Table 2

U.S. Corporate Defaults Rose To 77 In 2019

The U.S. corporate default tally rose to 20 in the fourth quarter from 13 in the third. For the full year, defaults were up 64% to 77 in 2019, from 47 in 2018. The consumer products sector had the most defaults in the fourth quarter, with four. We expect the U.S. trailing-12-month speculative-grade corporate default rate to rise to 3.9% by September 2020, from 3.1% at the end of September 2019.

The number of issuers rated 'B-' or lower rose by 18% to 552 over the 12 months to the beginning of the fourth quarter of 2019. With this growth, the pool of potential defaulters has increased. The number of weakest links increased to 197 in the fourth quarter from 179 in the third, marking the highest number since second-quarter 2009. Weakest links are issuers rated 'B-' or lower with negative outlooks or ratings on CreditWatch negative, and these issuers typically show the greatest default risk.

The number of potential downgrades (issuers with negative outlooks or ratings on CreditWatch with negative implications) increased to 356 from 331, and the number of potential upgrades (issuers with positive outlooks or ratings on CreditWatch with positive implications) decreased to 128 from 138 (see table 3).

Table 3

New Rising Stars Exceeded Fallen Angels In The Fourth Quarter

More U.S. companies became rising stars (issuers upgraded to investment grade from speculative grade) than became fallen angels (issuers downgraded to speculative grade from investment grade) in the fourth quarter. The rising stars tally reached seven, the most since second-quarter 2017. Six were upgraded from 'BB+'. Of those six, five were upgraded to 'BBB-' (Ally Financial Inc., Micron Technology Inc., Centene Corp., Steel Dynamics Inc., and Diamondback Energy Inc.) and one was upgraded to 'A' (Versum Materials Inc.). One issuer, SemGroup Corp., was upgraded to 'BBB-' from 'B+', after it was acquired by Energy Transfer L.P.

There were four fallen angels in the fourth quarter. Each of these companies was downgraded from 'BBB-'. Three were downgraded to 'BB' (MEDNAX Inc., Buckeye Partners L.P., and DPL Inc./ The AES Corp.) and one was downgraded to 'BB+' (Newell Brands Inc.).

The number of rising stars and their dispersion across sectors could be indicators of improving business activity. However, considering the number of sectors with negative bias above long-term averages, the picture becomes murkier. It may be that outcomes are diverging where strong companies are capitalizing on easier monetary policy and sustained economic growth, while weaker companies tread water or worse, in some cases, as indicated by the uptick in defaults.

Table 4

Table 5

Related Research

• U.S. Auto Sales Will Slip Into Low Gear In 2020-2021 After A Resilient 2019, Jan. 22, 2020
• Global Corporate Defaults Totaled 117 In 2019, Jan. 2, 2020
• Default Risk Climbs Among The Lowest-Rated Issuers, Dec. 11, 2019
• Economic Research: Fewer Signs Of Scrooge-ing Up U.S. Growth In The New Year, Dec. 4, 2019
• U.S. Business Cycle Barometer: Walk The Line, Nov. 25, 2019
• The U.S. Speculative-Grade Corporate Default Rate Is Expected To Reach 3.9% By September 2020, Nov. 19, 2019
• The U.S. Distress Ratio Grows To 8.5%, Nov. 18, 2019
• A Double-Digit U.S. Default Rate Could Be On The Horizon, Oct. 2, 2019