The current volatility in credit markets, which started with the spread of COVID-19 and was compounded by an oil price collapse due to a Saudi Arabia-Russia price war, continues to weigh on the sector. Despite central bank programs aimed at providing liquidity and calming investor sentiment easing markets to a significant degree, the speculative-grade market remains significantly vulnerable. Notably, the distressed ratio (defined as the proportion of speculative-grade issues with option-adjusted composite spreads of more than 1,000 basis points, or bps, relative to U.S. Treasuries) is now at 30.2% after hitting 44% on March 23 with unprecedented speed. More broadly, speculative spreads at 'BB' and 'B' rating levels widened by 125% and 113%, respectively, since the beginning of the year (see chart 1).

Nonetheless, speculative-grade spreads have eased slightly since 2020 highs in March after shutting down for about a month. U.S. markets are beginning to experience some relief due to the Federal Reserve's announcement of stimulus packages designed to ease short-term liquidity and the credit freeze, supporting investment-grade credit. But S&P Global Ratings is seeing slowly building investor confidence for higher-rated speculative grade debt. Issuance has picked up from unpresented low levels in March (see chart 2).

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Oil And Gas Leads The Distress Ratio Amid Increasing Supply-Demand Imbalances

The steep fall in oil prices due to the ongoing Saudi Arabia-Russia oil price war has led to an increase in oil and gas distressed ratio to 69.8% from 27.8% in January, totaling $64.6 billion dollars of debt outstanding.

Since the beginning of February 2020, the U.S. oil and gas sector has come under immense pressure after Saudi-led OPEC decided to boost its maximum production rate instead of extending existing production cuts, which led to a price war with Russia. Demand for crude in the U.S. has dropped dramatically as more states turn to social distancing as a response to the COVID-19 pandemic. As a result, West Texas Intermediate (WTI) prices plummeted to $14.1 per barrel as of March 30 from January levels of $63.3 per barrel before improving to $28.3 per barrel by April 3, then falling to $22.9 per barrel as of April 9. The oil and gas five-year speculative-grade spread that was near 909 bps as of Dec. 31, 2019, has now widened to 2,782 bps as of April 9. This provoked a surge in oil and gas distressed credits to 162 as of April 10, 2020, from 42 as of Dec. 31, 2019, pushing up the distress ratio to nearly 70% from 27.8% (see chart 6).

Our WTI price assumption is at $25 per barrel for 2020. The producers, particularly those in North America, are under tremendous pressure by investors to limit spending, maintain positive free cash flow, and enhance shareholder returns (see "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure," published March 20, 2020, on RatingsDirect). Oil and gas producers managed to make strong cost-cutting and significant balance-sheet adjustments in the 2015-2016 cycle, which has limited their capacity to repeat similar financial adjustments of this magnitude. If oil prices remain weak and the pandemic continues, this could elevate distressed debt instruments, followed by an increase in default rates.

Four other sectors have distress ratio higher than 35%, including retail and restaurants (44.6%), transportation (43.2%), automotive (36.7%) and midstream and merchant power (36.5%). Collectively, these sectors represent 157 distressed credits that cover more than a quarter of the distressed debt outstanding--some $65 billion in total. The retail and restaurant, transportation, and auto sectors have been greatly impacted by low business activity due to containment measures by various governments to restrict the spread of COVID-19, while the midstream and merchant power sector (which comprises midstream, refinery, and merchant power companies) faces a direct impact to the prolonged lower hydrocarbon prices.

Speculative-Grade Financial Institutions Have Also Propped Up This Month's Distress Ratio

Apart from oil and gas, the financial institutions sector has seen a large rise in distress ratios to 29.4% with the addition of 87 distressed credits from fallen angel Ford Motor Credit Co. LLC. We lowered our issuer credit rating on the firm to 'BB+' from 'BBB-' on March 25, 2020, due to supply-side and demand-side shocks to light-vehicle demand brought about by the spread of COVID-19 (see " Ford Motor Co. And Subsidiary Ratings Lowered To 'BB+' And Placed On CW Negative Due To Weaker Metrics, Pandemic Risk ," published March 23, 2020). Fortunately, the Fed has extended its corporate bond-buying program to include fallen angels that we rated as investment grade as of March 21, alleviating some of Ford's liquidity pressures.

For the financial institutions sector as a whole, we think the combination of the $2.3 trillion lending programs that the Fed announced last week and the recently passed government stimulus package will offset some asset-quality deterioration for bank and nonbank financial institution (NBFI) lenders. Without those programs and other steps taken to support financial stability, we believe the material challenges banks and NBFIs are now facing because of the pandemic would likely be far greater (see "Who The U.S. Government Plans Help, Who They Don't, And What That Means For Financial Institutions," published April 16, 2020).

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Related Research

• S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure, March 20, 2020
• Retail Is The Most Distressed U.S. Sector, May 13, 2019