In the fourth quarter of 2020, U.S. investors' optimism for 2021 rose after the Food and Drug Administration authorized two COVID-19 vaccines for emergency use and former President Donald Trump signed a $900 billion stimulus package in late December. The number of U.S. corporate upgrades rose by 51% in the fourth quarter, to 65, reaching the highest level since second-quarter 2018. Most of these upgrades were from issuers rated speculative-grade ('BB+' or lower), and nearly half were from issuers rated 'B-' or lower (see chart 1).

Chart 1

While the pace of upgrades accelerated to more than 20 per month in the fourth quarter, this remains far below the more than 200 downgrades per month in March and April (see chart 2). Downgrades reached a new high of 910 for full-year 2020, and this contributed to the growth of the speculative-grade proportion of U.S. corporate ratings. Speculative-grade ratings are now at an all-time high of 58% of financial and nonfinancial corporate ratings.

Chart 2

Even With Recent Declines, Negative Bias Remains Elevated

While new vaccines and stimulus measures support investor optimism for 2021, clouds still loom on the horizon. New daily COVID-19 infections reached new highs in the U.S. in January, and multiple states have reported cases of a new, more infectious U.K. variant of the virus.

Even though U.S. economic growth is recovering, we expect the recovery to take years--not quarters--before economic activity returns to its potential growth path from before the pandemic. S&P Global Economics forecasts U.S. real GDP will grow 4.2% in 2021 after an expected contraction of 3.9% in 2020, and the U.S. unemployment rate is unlikely to fall to its pre-pandemic low until after 2023. President Joe Biden's proposed American Rescue Plan also presents a substantial upside to the forecast. A new stimulus round, even if less than the proposed $1.9 trillion, is likely to boost the U.S. economy back to pre-COVID-19 levels sooner.

For U.S. companies, downgrade potential (as measured by negative bias, or the proportion of issuers with negative outlooks or ratings on CreditWatch with negative implications) remains elevated, even though it continues to steadily decline. The overall negative bias (including both investment-grade and speculative-grade) fell by 5 percentage points to 36% at the end of the quarter and remains above its long-term average of 22%.

Most of the issuers with negative outlooks or CreditWatch implications are speculative-grade. The speculative-grade negative bias dropped by 7 percentage points to 40% in the fourth quarter (and remains above its long-term average of 26%). The investment-grade ('BBB-' or higher) negative bias declined by 1 percentage point to 25% (holding above its long-term average of 17%) (see charts 3 and 4).

A number of sectors and companies are already beginning to benefit from the economic recovery, leading to increased upgrade potential for some issuers. The speculative-grade positive bias (the proportion of issuers with positive outlooks or ratings on CreditWatch with positive implications) rose during the quarter by 3 percentage points to 7%, while investment-grade positive bias rose by 1 percentage point to 3%. Nonetheless, some sectors are not expected to recover their credit metrics to 2019 levels until 2023 and after.

Chart 3

Chart 4

The share of total investment- and speculative-grade issuers with ratings on CreditWatch negative declined during the quarter (see chart 5). A rating on CreditWatch indicates a 1-in-2 chance of a rating change within the next 90 days, while a negative outlook indicates a 1-in-3 chance of downgrade within up to two years for investment-grade companies and generally up to one year for speculative-grade companies. Fewer companies on CreditWatch negative suggests that downgrade risk continues to shift from the near term into the intermediate term.

Chart 5

Lower-Rated Companies Remain At Highest Risk Of Downgrade

Companies at the lowest rating levels show the highest risk of downgrade. About 92% of issuers rated 'CCC+' or lower have negative bias, and 51% of issuers rated 'B-' have negative bias (see chart 6). 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.

Meanwhile, the positive bias is highest for issuers at the 'B+' and 'BB+' rating levels, at near 4% each, although this is much lower than the negative bias at these rating levels.

Chart 6

Most Sectors Show Reduced Negative Bias

With optimism growing for 2021, negative bias declined by 1 percentage point or more in 13 of 18 U.S. sectors in the fourth quarter.

The negative bias for the retail and restaurants sector fell over 15 percentage points to 41%, with a widely available vaccine in 2021 expected to provide relief for some issuers (see chart 7). We broadly expect credit metrics in the casual dining and apparel subsectors to recover in 2022, although revenue for some retailers exposed to apparel may never recover due to an acceleration of secular trends toward casual attire. Credit metrics for some issuers in these subsectors are not expected to recover before 2023. The weakest-rated issuers will remain under pressure, and about 31% of issuers in the retail and restaurants sector are rated 'B-' or lower.

Chart 7

The automotive sector's negative bias continued to fall in the fourth quarter, down 23 percentage points to 43%. Better-than-expected U.S. light vehicle sales in 2020 contributed to the reduced downgrade risk. However, we do not think this recent demand is sustainable, and we expect sales to remain below 2019 levels through 2022. Auto suppliers have experienced the most credit deterioration in the sector amid the pandemic, and credit metrics for these issuers aren't expected to recover until 2022.

The oil and gas sector's negative bias fell 6 percentage points in the fourth quarter to 63%, which remains the highest among all sectors. Oil and gas prices increased during the quarter, and West Texas Intermediate ended 2020 near the average break-even price of $50 per barrel for U.S. shale. However, weaker-rated companies, particularly those with large exposure to oil, remain vulnerable to negative rating actions. About 34% of issuers in the sector are rated 'B-' or lower. This share has dropped by nearly 10 percentage points since the middle of 2020, but due in part to the concentration of defaults in the sector.

Chart 8

The media and entertainment sector's negative bias fell over 7 percentage points but remains elevated at 54%, the second highest among all sectors. The recovery for out-of-home entertainment issuers, such as those in the leisure, live events, and movie exhibitor subsectors, will depend on consumer behavior as the pandemic ends, with a return to more normal activity possible once vaccines become widely available. However, a full recovery is unlikely before 2022.

Even if consumer activity begins to rebound later this year, already weakened issuer credit metrics may not recover until 2023. After the pandemic worsened secular pressures, some companies will remain at risk of negative rating actions even after a recovery takes hold. The media and entertainment sector has the largest concentration of weaker-rated issuers among all sectors, with over 40% of issuers rated 'B-' or lower and over 70% rated in the 'B' and 'CCC'/'C' categories.

Fewer Sectors Now Show Above-Average Downgrade Potential

One way we examine downgrade propensity is by comparing the current negative bias with the historical average. The number of sectors with above-average negative bias fell to 15 in the fourth quarter from 17 at the end of the third quarter (see chart 9). The high technology, insurance, and telecommunications sectors display negative bias below their long-term averages. The sector with the negative bias that's highest above its historical average is oil and gas (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. Only the automotive and the retail and restaurants sectors show above-average upgrade potential (see chart 11).

Chart 11

Upgrades Increase By 51%; Downgrades Continue To Fall

U.S. corporate upgrades rose by 51% in the fourth quarter to 65, the highest number since second-quarter 2018 (which had 67 upgrades). Downgrades totaled 88 in the fourth quarter, down 18% from the third quarter. Nonfinancial corporate issuers accounted for most of the rating actions, with 81 downgrades and 62 upgrades. Financial services issuers had just seven downgrades during the quarter and three upgrades (see chart 12).

Chart 12

Speculative-grade downgrades declined by 18% in the quarter, to 78, their lowest level since fourth-quarter 2018. Investment-grade downgrades fell to 10 (from 12 in the third quarter).

The number of speculative-grade upgrades rose by 50% in the quarter to 60, reaching their highest level since first-quarter 2018. The number of investment-grade upgrades was up slightly, to five (from three in the third quarter) (see chart 14).

Chart 13

Chart 14

Table 1

Half Of Fourth-Quarter Rating Actions Were For Issuers Rated 'B-' And Lower

Rating trends are beginning to diverge for the lowest-rated issuers as issuance remains robust while business conditions remain challenging for many. Issuers rated 'B-' and lower accounted for the highest proportions of both downgrades and upgrades in the fourth quarter. About 51% of downgrades were of issuers rated 'B-' and lower (see chart 15), while 49% of upgrades were from issuers rated at that level.

Most of these downgrades were of companies rated 'CCC+' and lower, which have the weakest credit metrics and have been less resilient to the rapid deterioration of business and economic conditions. Many of these upgrades reflected better-than-expected financial performance, improved refinancing prospects, or increased liquidity.

Chart 15

Oil And Gas, Utilities Lead Downgrades, While Retail And Restaurants Lead Upgrades

The oil and gas and utility sectors had the highest number of downgrades in the fourth quarter, with 15 each, up slightly from 12 and 11 in the third quarter, respectively. All of the fourth-quarter downgrades in the oil and gas sector were of speculative-grade companies, and most of the utility sector downgrades were for speculative-grade midstream companies. In the oil and gas sector, Occidental Petroleum Corp. was the largest downgraded issuer by debt amount, while in the utility sector, FirstEnergy Corp. was the largest downgrade (and was downgraded twice during the quarter).

The media and entertainment sector had the third-highest number of downgrades, with 13, down from 21 in the third quarter. We downgraded 12 speculative-grade issuers in the sector during the fourth quarter. The largest downgrade in the sector was of The Walt Disney Co., which accounted for most of the debt affected by downgrades in the sector.

The health care sector had the fourth-highest number of downgrades, with seven, up from just two in the third quarter, but it had the largest amount of affected debt. The largest issuers downgraded were Pfizer Inc. (following the divestiture of its Upjohn segment), Gilead Sciences Inc. (following its acquisition of Immunomedics Inc.), and Community Health Systems Inc. (which defaulted as it completed a distressed exchange). Five of the fourth-quarter downgrades were of speculative-grade issuers.

The retail and restaurants sector had the highest number of fourth-quarter upgrades, with 12. These upgrades were largely of speculative-grade retail companies operating in home-related, sports and outdoors, and food segments. The largest issuers upgraded were Albertsons Cos. Inc. and PetSmart Inc. (which was upgraded in October after it announced plans to refinance and reduce total funded debt, but was subsequently downgraded after the transaction was canceled).

Chart 16

Table 2

Two Fallen Angels In The Fourth Quarter

Fallen angels (issuers downgraded to speculative-grade from investment-grade) totaled two in the fourth quarter, down from three in the third quarter. These were real estate investment trust EPR Properties and electricity distributor FirstEnergy Corp. There was one rising star (an issuer upgraded to investment-grade from speculative-grade) in the quarter: The AES Corp.

Table 3

Defaults Declined In The Fourth Quarter

U.S. corporate defaults reached their highest annual total in the past decade in 2020, with 146, up from 77 in 2019. Despite this year-over-year increase, the pace of quarterly defaults slowed in the second half of the year. The default tally fell to 26 in the fourth quarter from 37 in the third.

Following the record number of downgrades in 2020, ratings are increasingly concentrated at lower levels. Speculative-grade ratings account for 58% of U.S. corporate ratings (including financial and nonfinancial issuers) and 69% of nonfinancial corporate ratings, both all-time highs. About 23% of U.S. corporate ratings (and 39% of speculative-grade ratings) are 'B-' and lower--both also near all-time highs (see chart 17).

The number of weakest links (issuers rated 'B-' or lower with negative outlooks or ratings on CreditWatch negative) fell to 339 during the quarter from 391 at the end of the third quarter. Still, the number of weakest links is significantly higher than in fourth-quarter 2019. Weakest links are the issuers at greatest risk of default.

Typically, spikes in the number of issuers at the lowest rating levels lead defaults by about four to five months. The concentration of issuers at the lowest rating levels supports our view that the U.S. trailing-12-month speculative-grade corporate default rate will continue to climb, reaching 9% in September 2021. Some of this default risk has been offset by a stronger-than-expected pace of economic growth in the second half of 2020, and by supportive market conditions with robust issuance. Also lessening the default risk, speculative-grade maturities in 2021 are relatively small and concentrated at the 'BB' level--the higher end of speculative-grade ratings.

Chart 17

Table 4

Table 5

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

• U.S. Biweekly Economic Roundup: Stir It Up, Jan. 22, 2021
• U.S. Corporate Credit Outlook 2021: Economic And Political Transition, Jan. 21, 2021
• U.S. Real-Time Data: COVID-19 Is Still Calling The Shots, Jan. 15, 2021
• Here's What The U.S. Media And Entertainment Sector Has In Store For 2021, Jan. 6, 2021
• 'BBB' Pulse: Fallen Angels Tally Remains Flat In November, Dec. 16, 2020
• Industry Top Trends 2021 Autos, Dec. 10, 2020
• Industry Top Trends 2021 Media And Entertainment, Dec. 10, 2020
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• Industry Top Trends 2021 Retail And Restaurants, Dec. 10, 2020
• The U.S. Speculative-Grade Corporate Default Rate Could Rise To 9% By September 2021, Nov. 23, 2020
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