The number of potential bond downgrades (defined as issuers rated 'AAA' to 'B-' by S&P Global Ratings with either negative rating outlooks or ratings on CreditWatch with negative implications) fell by 84 in February to 1,052. Still, this is 60% above February 2020 levels (649). Of the 107 removals since January, 94 were due to outlook/CreditWatch revisions; 16 of those were accompanied by downgrades. Meanwhile, we added only 23 issuers, 19 of these followed a revision in their outlook/CreditWatch status to negative (see table 1). There were 29 downgrades on the January list, 10 of which remained on the list as of February 28, with eight downgrades, mostly from the oil and gas sector. At the same time, the count of potential bond upgrades (issuers we rate 'AA+' to 'B-' with either positive outlooks or ratings on CreditWatch with positive implications) rose to 205 from 186 the previous month--we added 38 issuers and removed 19. Thirty-six additions occurred due to a change in the outlook or CreditWatch status of the rating, two of which were accompanied by an upgrade. With eight new issuers, consumer products is the sector that saw most additions in February, followed by financial institutions with six new issuers. Outlook and CreditWatch changes were the reason for 16 of the 19 removals and 11 were accompanied by an upgrade.

The gap between potential downgrades and upgrades narrowed for the seventh consecutive month as potential bond downgrades fell sharply, while potential bond upgrades continued to rise, adding 19 issuers in February. In July 2020--at the widest point, we tallied 1,365 potential downgrades and 104 potential upgrades compared with 1,052 potential downgrades and 205 potential upgrades at the end of February. Consequently, the gap lessened to 847 from 1,261 at the same time. The gap is now narrower than its peak during the global financial crisis when it stood at 889 in March 2009 (see chart 1). This means credit deterioration will continue in the coming month, albeit at a slower pace than in 2020. Issuers at lower rating levels will remain vulnerable to worsening financing conditions following a sudden shock or negative change of events.

Chart 1

The Quality Of Speculative-Grade Credit Ratings Has Deteriorated Since The Beginning Of The Pandemic

After having increased to more than half of our rated issuers in 2011, the share of speculative-grade issuers gradually grew to 57.4% at the beginning of 2020. This included 18.7% rated 'BB', 34.8% rated at the 'B' level, and 4% rated 'CCC+' or below. While the total speculative-grade proportion remains unchanged at 57.4% as of Feb. 28, 2021, the proportion of issuers rated 'BB', 'B' and 'CCC/C' has changed over the past 12 months. Most of this took place through May 2020--the proportion of 'BB' and 'B' ratings dropped to 17.4% and 32%, respectively, while the share of 'CCC/C' ratings rose to 7.9% following a high number of pandemic- or oil-price-related downgrades from March to May 2020.

The probability of default increases during a time of crisis and is most concentrated among the lowest rated issuers. By mid-2020, following the transition of issuers into the 'CCC/C' rating category, defaults rose, reaching 226 for full-year 2020 compared with 118 in 2019. In 2020, 86% of the defaults occurred after the first quarter. Prior to default, 198 issuers had been rated 'CCC/C' and 11 were rated 'B'. 17 issuers defaulted after we withdrew our ratings. As of Feb. 28, 2021, the proportion of issuers rated 'CCC/C' stood at 7.2%, 3.2 percentage points (ppts) above its share a year earlier but 0.7 ppts below its share in March 2020, hinting at a slightly weaker default rate over the coming months (see chart 2).

Chart 2

ESG-Related CreditWatch Placements On 10 Oil And Gas Issuers Were Resolved In February

We placed nine oil and gas issuers on CreditWatch with negative implications in January after we revised our risk assessment for the oil and gas integrated, exploration, and production industry to moderately high risk from intermediate risk. Subsequently, the tally of oil and gas issuers we placed on CreditWatch with negative implications rose to 10 in January. (see "The Change To The Industry Risk Assessment For Exploration & Production Companies And What It Means For Issuer Ratings," Jan. 25, 2021). All 10 CreditWatch placements were resolved in February: seven issuers were downgraded and the CreditWatch placements of three issuers were removed with an affirmation of the rating. As we highlighted in our previous report, six of these downgrades (Total SE, Royal Dutch Shell PLC, Exxon Mobil Corp., ConocoPhillips, Chevron Corp., and Canadian Natural Resources Ltd.) stemmed from environment-related ESG-concerns. Our downgrade of TechnipFMC PLC was not driven by ESG considerations. We affirmed our ratings and revised their outlooks to stable on China Petrochemical Corp. and China National Offshore Oil Corp. (see chart 3). We think these Chinese national oil companies are better positioned to withstand the industry's challenges due to government support and China's oil and gas consumption growth. We revised the rating outlook on Woodside Petroleum Ltd. to negative in consideration of the issuer's higher exposure to liquified natural gas vis-à-vis peers and its low-cost portfolio of assets. Therefore, it remains on our list of potential downgrades.

Chart 3

Financial Institutions Still Make Up The Highest Number Of Potential Downgrades

Financial institutions continue to lead the tally of potential bond downgrades with 145, followed by the media and entertainment sector with 133 (see chart 4). However, the rating distribution among potential downgrades in these two sectors are very different: 65% of those in the financial institutions are rated investment grade versus only 19% of the corporates in media and entertainment. What's more, the share of 'A' or 'AA' rated issuers in financial institutions is 27%, while there is only one such potential downgrade from the media and entertainment sector. The concentration at the opposite end of potential bond downgrades' rating levels is diametrically opposed: 13% of financial institutions and 60% of media and entertainment corporates on our list are rated 'B'. These highly dissimilar rating distributions show a similarly different ratings vulnerability in the two sectors, which together account for 26% of all potential bond downgrades.

Chart 4

Near-Term Downgrade Risk In February Increased Over January

Another factor indicating a higher degree of ratings vulnerability is the ratio of potential downgrades carrying a negative outlook compared with those placed on CreditWatch with negative implications, with a higher number indicating lower near-term vulnerability. In February, the number of issuers on our list with a negative ratings outlook dropped to 981 from 1,062 in January, while the number of issuers we placed on CreditWatch negative decreased to 71 from 74. As a result, the ratio of outlook to CreditWatch placements tightened to 13.8 to 1 from 14.4 to 1. Despite a decline in the total downgrade potential, this indicates a increased short-term downgrade risk within the pool of potential downgrades, over the previous month. Ratings placed on CreditWatch with negative implications carry a higher downgrade risk than those with a negative outlook because issuers are placed on CreditWatch negative when there is an event or a deviation from an expected trend or material change in the issuer's performance, but its magnitude is not yet determined or there is a change in rating criteria. This may not necessarily lead to a downgrade, but the tight timeline of 90 days shows a high likelihood that a rating action in the relevant direction will follow (see "General Criteria: Use Of CreditWatch And Outlooks," Sept. 14, 2009).

Media And Entertainment Continues To Be The Sector Most Affected By The Pandemic

The pandemic, along with containment measures aimed to restrict its spread, have severely hurt business conditions for tourism and leisure businesses in 2020. With new waves of infections and highly contagious variants, the return to normal still lies a bit ahead in many regions. Therefore, we think the media and entertainment sector might continue to be challenged . The sector's vulnerability to this situation is shown by the strong divergence between its downgrade proportion over the past 12 months and the past five years (see chart 5). While the oil and gas sector has seen the second highest downgrade proportion over the past year, it is still below its five-year-average.

Chart 5

Table 1

Table 2

Table 3