Second-Quarter 2020 Marks The First Time That U.S. Quarterly Downgrades Exceeded 400

S&P Global Ratings lowered 414 long-term issuer credit ratings in the second quarter, surpassing the prior peak of 331, which was set in first-quarter 2009. The number of monthly downgrades peaked at 268 in April before falling in May and June as states eased social distancing measures to restart economic activity (see chart 1).

Chart 1

Downgrade Potential Reaches New High For Speculative-Grade Companies

Companies that entered this stress period with weaker credit metrics have been particularly challenged by the shocks to economic and funding conditions. The negative bias (the percentage of issuer credit ratings with negative outlooks or on CreditWatch with negative implications) for speculative-grade ('BB+' and lower) companies reached a historic quarter-end high of 52%, even as the negative bias of 26% for investment-grade companies remains below its 2009 peak of 28% (see charts 2 and 3).

Chart 2

Chart 3

While we expect the economic recovery to begin in the second half of this year, credit quality is likely to take longer to recover. The time horizon for potential downgrades has shifted from the near term to the medium term. The share of companies with ratings on CreditWatch with negative implications declined at the end of the second quarter, even as the share of ratings with a negative outlook increased (see chart 4). A rating on CreditWatch indicates a one-in-two chance of a rating change within the next 90 days, while a negative outlook indicates a one-in-three chance of downgrade for up to two years for investment-grade companies and generally up to one year for speculative-grade companies. 

Chart 4

Downgrade potential is highest among the lowest-rated issuers. With their weaker credit metrics, lower-rated entities are not as well-positioned to weather a business, financial, or economic shock as higher rated peers. By rating level, the lowest level of 'CCC'/'C' has the highest negative bias, at 92%, followed by 'B-' rated issuers, which have a negative bias of 51% (see chart 5).

Chart 5

As the effects of the coronavirus pandemic and the sudden-stop recession are being felt across all sectors, negative bias rose in all 18 sectors in the second quarter (see chart 6).

Chart 6

The automotive sector negative bias jumped 37 percentage points to 83% and is now the highest among all sectors (see chart 7). This came as S&P Global Ratings revised its estimate for light vehicle sales in 2020 lower to 12.7 million units, a 25% drop from 2019. Even with a recovery, we expect sales to remain 10% to 15% below 2019 levels in 2021.

The oil and gas sector now has the second-highest negative bias at 81% after increasing 17 percentage points during the quarter. Nearly half of all rated oil and gas issuers are rated 'B-' or lower, and most rating actions among speculative-grade issuers have been due to difficulties accessing capital markets. As a result, we expect the rate of distressed exchanges and bankruptcies in the sector to increase substantially over the next year.

The media and entertainment sector had the third-highest negative bias at the end of the second quarter at 64%, an increase of 9 percentage points since the end of the first quarter. This sector includes the leisure subsector, which has been particularly affected by social-distancing measures. Most rating actions have been concentrated among travel-related issuers, issuers in local media, live events issuers, and movie exhibitors. More downward rating actions are expected in the coming months, especially if the pace of economic recovery is slower than anticipated.

Chart 7

Chart 8

All Sectors Now Have A Negative Bias Above Their Long-Term Averages

One way we examine downgrade propensity is by comparing the current negative bias with the historical average. Currently, all 18 sectors show a negative bias above their long-term average, an increase of five sectors during the quarter. This is the first time that all 18 sectors have an above-average negative bias.

Autos and oil and gas are the sectors with current negative biases that are highest above their historical averages (see chart 9).

We use a similar approach to gauge upgrade potential, comparing the current positive bias of a sector with its long-term average. Currently, no sectors show above-average upgrade potential (see chart 10).

Chart 9

Chart 10

Speculative-Grade Nonfinancial Companies Lead Downgrades

U.S. corporate downgrades totaled 414 in the second quarter, and this is the first time quarterly downgrades have topped 400.   Nonfinancial corporate issuers accounted for 405 of the downgrades, and just nine were from financial services (see chart 11).

Chart 11

The number of speculative-grade downgrades increased by 49% in the quarter (to 379), while investment-grade downgrades fell by 24% (to 35), (see chart 12). Meanwhile, the total number of upgrades fell by 35% to 22 (see chart 13).

Chart 12

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Table 1

Second-Quarter Downgrades Were Concentrated In The Lowest Rating Categories

The majority of downgrades in the quarter were from issuers rated 'B+' and lower because companies with weaker credit metrics were less able to withstand the rapid deterioration of business and economic conditions.   While issuers rated 'B+' and lower have grown to account for 42% of U.S. issuer credit ratings, these issuers represented an even higher share of downgrades in the second quarter (with 75%). Issuers rated 'B-' or lower accounted for nearly 39% of downgrades, while issuers rated 'B+' or 'B', accounted for 36% (see chart 14).

Chart 14

Four Sectors Continue To Lead Downgrades

The same four sectors continued to lead downgrades in the second quarter that led in the first.

Media and entertainment tops the list again with 80 downgrades (up from 48 in the first quarter). Nearly all of the downgrades were speculative-grade issuers (74) and just over half of the downgrades (41) were concentrated in the hotel or leisure industries.

Downgrades in the consumer products and retail and restaurants sectors remained elevated in the second quarter. Consumer products sector downgrades increased to 50 from 33 in the previous quarter, while retail and restaurants sector downgrades increased to 34 from 27. Nearly all of the downgrades in each sector were speculative-grade issuers (49 of 50 in consumer products and 33 of 34 in retail and restaurants). In the retail and restaurants sector, rating actions have been concentrated among dine-in restaurants, department stores, issuers within apparel, and issuers with specialty offerings. In the consumer products sector, rating actions have been concentrated among issuers within durable goods, apparel, food service, and cosmetics. Liquidity concerns are paramount in each sector amid tighter financing conditions for the weakest rated issuers.

We expect consumer sentiment to remain depressed even after states broadly reopen and traffic patterns begin rebounding. Sales for many issuers within retail and restaurants aren't expected to return to 2019 levels until 2022 with risks tilted to the downside, and issuers in discretionary subsectors of the consumer products sector likely face a similar outlook. More negative rating actions are expected in each sector.

Oil and gas sector downgrades remained elevated in the second quarter, increasing to 48 from 41 in the previous quarter. All of the downgrades were speculative-grade issuers.

New to the top five, the capital goods sector had 36 downgrades in the second quarter, up from just 14 in the previous quarter. Nearly all of the downgrades were speculative-grade issuers (32). The COVID-19 pandemic added significant pressure to a sector that was already vulnerable due to ongoing strain from the U.S.-China trade war, further disrupting supply chains and causing end-market demand to weaken even more. More negative rating actions may be ahead as the sector has the sixth-highest negative bias at 54% after spiking 28 percentage points (second most) during the second quarter (see chart 15 and table 2).

Chart 15

Table 2

Fewer Fallen Angels In The Second Quarter

Fallen angels (issuers downgraded to speculative grade from investment grade) totaled six in the second quarter after spiking to 13 in the first-quarter. All six issuers operate in different sectors and were downgraded from 'BBB-', the lowest investment-grade rating. Two of the issuers were downgraded by two notches to 'BB' (Royal Caribbean Cruises Ltd. and Tech Data Corp.) and four were downgraded by one notch to 'BB+' (Hillenbrand Inc., Service Properties Trust, Trinity Industries Inc., and Rockies Express Pipeline LLC). Global cruise operator Carnival Corp. was also downgraded to speculative grade during the second quarter, although this issuer is not included in this group of U.S. fallen angels as it is incorporated in Panama.

There was one rising star (upgraded to investment grade from speculative grade) in the quarter. We upgraded FGL Holdings to 'BBB-' from 'BB+' in June after it was acquired by Fidelity National Financial Inc. (see table 3).

Table 3

Defaults Spiked In The Second Quarter

The number of U.S. corporate defaults nearly tripled in the quarter, rising to 60 from 21 in the first quarter. The 81 defaults in the first half of 2020 outnumber 2019's full-year total of 77.

With a growing number of downgrades and the proportion of issuers with a negative bias, the number of weakest links rose to 432 during the quarter (from 318 at the end of the first quarter). 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.

This growing number of weakest links supports our view that the U.S. trailing-12-month speculative-grade corporate default rate will continue to climb, reaching 12.5% in March 2021.

Table 4

Table 5

Related Research

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• U.S. Lodging, Leisure, And Gaming Sectors Face Rocky Road To Recovery, June 30, 2020
• The U.S. Faces A Longer And Slower Climb From The Bottom, June 25, 2020
• U.S. Autos Rating Action Summary And Key Takeaways Following COVID-19 Related Forecast Revisions, June 15, 2020
• U.S. Consumer Product Ratings Demonstrate Pandemic's Double Edge--Consumer Staples Benefit While Discretionaries Struggle, June 12, 2020
• Pandemic And Recession Deal Blows To Credit Metrics Of U.S. Media And Entertainment Industry, June 10, 2020
• The U.S. Speculative-Grade Corporate Default Rate Is Likely To Reach 12.5% By March 2021, May 28, 2020
• U.S. Upstream Oil And Gas Rating Action Summary And Key Takeaways Following The March 2020 Hydrocarbon Price Deck Revision, May 19, 2020
• Capital Goods Companies Face Shocks From COVID-19 And Economic Recession, April 27, 2020
• Impact Of The Coronavirus Likely To Drag U.S. Retail And Restaurants Ratings Down Further, April 24, 2020
• Global Credit Conditions--Triple Trouble: Virus, Oil, Volatility, April 1, 2020
• It's Game Over For The Record U.S. Run; The Timing Of A Restart Remains Uncertain, March 27, 2020
• The Global Recession Is Likely To Push The U.S. Default Rate To 10%, March 19, 2020