A surge in COVID-19 cases in the U.S., recessionary pressures, and weaker capital market conditions are weighing on corporate credit quality. That said, U.S. telecommunication companies (telcos) have historically been quite resistant to macroeconomic contractions. In wireless, the pandemic has caused the carriers to close stores, which will reduce gross postpaid subscriber additions and upgrade rates, but also lower churn. Supply chain impacts could also result in lower equipment revenue for the carriers, but bolster profitability.

S&P Global Ratings believes there is more risk in wireline, especially among companies with greater exposure to small and midsize businesses (SMBs) and, to a lesser extent, enterprise customers. Under normal conditions, we view wireline operators that derive a large portion of their revenue from business customers more favorably than providers that focus on the residential segment where competition is more intense. However, in a recession, we would expect many SMB customers to close locations and even go out of business. And, the spread of the COVID-19 pandemic could accelerate this process as many small businesses are facing a low- to zero-revenue environment for a period of time. An extended macroeconomic downturn could even prompt larger enterprise customers to reduce IT spending, bookings, and installations. In this article, we answer some frequently asked questions from investors on the large U.S. telcos.

How would asset underperformance affect unfunded pensions/other post-employment benefits (OPEBs)?  Although Verizon Communications Inc., AT&T Inc., and CenturyLink Inc. have very diverse portfolios of assets to fund their pensions and OPEBs, they still have significant exposure to the public equity markets. Therefore, a decline in equity values will hurt asset returns and could increase S&P's adjusted leverage. That said, the discount rate used to determine the pension and OPEB obligations is based on a hypothetical corporate bond yield curve, which could widen as equity returns decline, resulting in lower pension and OPEB obligations that would partly mitigate the lower asset returns.

We looked at three scenarios (that are not in our current base-case forecast) to determine the potential effect on net unfunded obligations. In each case, for asset returns, we assumed a 40% decline in equity values, coupled with a 15%-20% decline in high-yield and emerging market bonds while other instruments, including fixed income assets, experienced a more moderate decline in value. About 25% of Verizon's and CenturyLink's pension assets are public equity while AT&T's portfolio is closer to 30% equity. Additionally, about half of CenturyLink's portfolio is hedged, which limits the impact of market fluctuations. With respect to the pension and OPEB obligations, our scenarios for changes in the discount rate include: 1) no change; 2) a 25 basis point (bp) increase; and 3) a 50 bp increase.

Assuming the above asset returns with no increase in the applied discount rate, we would expect AT&T's net unfunded pension and OPEB balance to increase by about $7.9 billion. For Verizon and CenturyLink, we would expect a more modest increase in the pension/OPEB deficit of about $2.9 billion and $1.3 billion, respectively, with CenturyLink's portfolio partly benefiting from its hedging strategy. Using a higher discount rate of 25 bps or 50 bps would reduce the unfunded obligations. Overall, under these various scenarios, we would not expect leverage to deviate by more than 0.1x relative to our current base-case forecasts.

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Which company is best-positioned in a recession?  Of the three, we believe Verizon is best-positioned to withstand a macroeconomic downturn because it derives about 70% of its revenue from wireless operations, a business that we view as very recession-resistant given the utility-like nature of its products and services. In contrast, AT&T's mobility operations only account for about 40% of its revenue and its remaining business lines either face secular industry pressures or macroeconomic headwinds. More specifically, the company's video business, which comprises about 18% of revenue, is losing premium video subscribers at a rapid clip, including 3.4 million customer losses in 2019. Already facing secular industry pressures, an extended recession may push more consumers to cut the cord. Similarly, business wireline operations could see revenue declines accelerate because of lower corporate spending and higher unemployment. Its recent acquisition Warner Media increases its exposure to an economic downturn as advertisers reduce their advertising spend. Further, the COVID-19 pandemic has forced theaters to close and film studios to halt ongoing film and TV production and push back upcoming film releases. This will result in a sharp decline in theatrical revenue in the first half of 2020 and a potential working capital impact as the studios carry the cost of production long before receiving payment for delivery. Finally, the loss of NCAA March Madness and the potential cancellation of the NBA basketball season (at present, it has been postponed and we expect the league will try to hold the playoffs) will have a significant impact on advertising revenue at the Turner cable networks. As a result of these factors, we expect AT&T's adjusted EBITDA to decline about 5%-7% in 2020.

CenturyLink derives about 75% of its revenue from business customers, which we normally view favorably relative to the more competitive consumer segment. But given our expectation for a 1.3% decline in GDP in 2020, we believe much of CenturyLink's business is at risk. The SMB segment accounts for about 13% of its revenue, which could experience a sharp drop in revenue in 2020 following a 6% revenue decline in 2019. And, while enterprise and international revenue trends were showing signs of improvement in the second half of 2019, we believe there is heightened risk that revenues from these business lines will decline in 2020 as larger business customers defer or cancel projects, cut headcount, and reduce spending on telecom services, with a focus on cost cutting.

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If AT&T can't sell Warner Media receivables via the off-balance sheet securitizations, what will that do to its free cash flow?   As we have mentioned in previous reports, AT&T's free operating cash flow (FOCF) is distorted by its sale of Warner Media receivables through off-balance sheet securitizations, proceeds of which go through cash from operations. In 2019, the company generated about $29 billion of FOCF and $14 billion of discretionary cash flow (DCF). However, we estimate the Warner Media receivable sales inflated AT&T's FOCF by about $5 billion. In 2020, the company is forecasting about $28 billion of FOCF. However, if it is unable to sell its Warner Media receivables via securitizations, we expect this will likely reduce its FOCF as the company planned to do more of these transactions this year. Because AT&T will average about $11 billion of debt maturities every year for the next four years, lower DCF would leave the company with less cushion to pay down these obligations when they come due if credit market conditions continue to deteriorate. That said, with $15 billion in total revolver availability and its recent $5.5 billion term loan due Dec. 31, 2020, we believe AT&T has sufficient liquidity to address near-term maturities.

How will the recession affect CenturyLink's top-line performance and credit metrics?   We have updated our base-case forecast to include a sharp decline in SMB revenue in the double-digit-percent area and even a low to mid-single-digit-percent revenue decline in both the enterprise and international segments. Notwithstanding additional cost synergies, we expect EBITDA will decline 4%-6% in 2020. Our previous base-case forecast included leverage declining to about 3.8x in 2020 from 4.1x in 2019. Given the incremental pressure on the business, we do not expect any leverage improvement this year, and instead expect leverage reduction will resume in 2021 to the high-3x area. Nonetheless, we believe CenturyLink's credit metrics (including adjusted leverage below 4.5x) will remain supportive of the 'BB' issuer-credit rating and stable outlook.

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Does the current macroeconomic picture change S&P Global Ratings' outlook on Verizon?  Previously, we pointed to two potential hurdles that could hinder or delay Verizon's (BBB+/Positive/A-2) path for an upgrade to 'A-'. The first was the outcome of the proposed T-Mobile and Sprint merger, which underwent regulatory scrutiny for the past two years, and closed on April 1. The second issue was the potential for significant spending in upcoming spectrum auctions, including the CBRS auction and the C-Band auction (we believe that Verizon is interested in the C-Band spectrum, in particular). Verizon's adjusted debt to EBITDA was about 2.5x at year-end 2019, right on top of our threshold for a higher rating, and we expect leverage to improve to about 2.4x by year-end 2020 assuming spectrum purchases are limited to the $1.6 billion already spent in the mmWave auctions. The FCC has already delayed the CBRS auction to July 23 from June 25, which suggests that the C-Band auction could also be pushed back from its target date of Dec. 8, 2020. We currently estimate that if Verizon spent $15 billion on spectrum, it could still maintain leverage at around 2.5x in 2021, which would support a higher rating.

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Nonetheless, the COVID-19 pandemic and its economic impact add another layer of uncertainty to Verizon's business lines. Although wireless operations should be relatively stable in a recession because consumers are highly unlikely to disconnect their mobile devices, there are certain variables that could affect results. In the near term, with stores closing across the country, gross subscriber additions will likely decline but so will churn since customers are less likely to change carriers now, although we still expect slower net customer growth. Additionally, equipment revenue will fall partly because of supply chain issues but also because consumers are less likely to upgrade devices or switch carriers, although lower equipment revenue will also boost margins. Longer-term, higher levels of unemployment will likely increase churn in both the business and consumer segment as businesses disconnect laid-off employees and consumers seek out less-expensive plans. For Verizon, its business postpaid connections account for about 22% of its total postpaid subscribers.

Consumer wireline operations could benefit in the near term as more customers work from home and migrate to over-the-top video platforms, which could also push them to take faster broadband speeds, resulting in higher broadband revenue. Longer-term, higher levels of unemployment from a recession could prompt more people to cut the cord, although this would likely benefit margins. A greater concern is if job losses result in higher bad debt expense, especially for broadband services. At the same time, we believe business wireline performance could be hurt by weaker economic conditions, especially among SMB customers, which are most likely to churn.

Taking into account these various puts and takes, our current base-case forecast includes consolidated revenue declining in the low-single-digit percent area, EBITDA to be essentially flat, capital expenditures to be about $500 million higher based on the company's updated guidance, and DCF to fall about $500 million-$750 million in 2020.