S&P Global Ratings believes the business and consumer services industry worldwide is poised for growth this year, after some turbulence in 2020 as a result of COVID-19-related shocks and the ensuing global economic recession. We have taken negative rating actions on more than one-third of the companies we rate globally in this sector over the past 12 months. Last year's downgrades were mostly limited to one notch and involved issuers with high revenue exposure to cyclical sectors such as travel, hospitality, leisure, and oil and gas. Weak economic conditions also prompted a rise in the sector's default rate, though measures such as covenant waivers and equity infusions kept the rate limited. We believe the pace of further downgrades will continue to decelerate over the next 12 months given the high number of negative actions already taken in the past year, vaccine rollout progression, and improving global economic conditions. However, uncertainty about the evolution of the pandemic and its economic effects continues to temper our expectations and reflects the relatively high number of negative outlooks that remain across the portfolio. In this commentary, S&P Global Ratings addresses frequently asked questions about our ratings in the global business services industry since the start of the COVID-19 pandemic and the sector's likely path to recovery in 2021 and beyond.

Frequently Asked Questions

How severe has the ratings impact of COVID-19 been on the global business and consumer services sector, and how will the pandemic affect credit quality in 2021?

Overall, the credit quality of the global portfolio has weakened somewhat since the start of the pandemic. We have downgraded about one-fifth of our publicly rated issuers by at least one notch since March 2020. However, multinotch downgrades affected only a handful of issuers (see chart 2), mostly with exposure to cyclical sectors. Rating actions have been concentrated in our speculative-grade universe (issuer credit ratings of 'BB+' and below), and our weakest issuers (rated 'B-' and below) have increased to approximately 40% of the portfolio, up from 32% as of March 2020. Issuers rated 'CCC+' or lower, which are typically vulnerable to nonpayment, have doubled and now represent 11% of the portfolio. Our investment-grade issuers have remained more robust with few rating changes and we expect this trend to continue.

Risks are still weighted to the downside in 2021 due to a high degree of uncertainty about the evolution of the pandemic--such as new virus variants--and related economic effects. Very few (about 3% of the portfolio) issuers currently have a positive outlook or are on CreditWatch with positive implications, versus over one-quarter of the portfolio that have a negative outlook or are on CreditWatch with negative implications. Nevertheless, we believe the pace of further downgrades will continue to decelerate sharply over the next 12 months as the vaccine rollout progresses and global economic conditions improve.

Chart 1

Chart 2

Which subsectors have been hardest hit by COVID-19, and which will spring back most swiftly in 2021?

We saw a steep and immediate hit to earnings for most issuers across the business services global portfolio following the onset of the pandemic. However, the impact varied substantially given the sector's diverse range of service offerings, industries, end-markets, and geographies. Issuers have taken a variety of measures to counteract the impact from COVID-19 and the weakening economy, and to bolster their liquidity positions. This includes improved working-capital management, hiring freezes, pay cuts, rent renegotiations, and use of government initiatives such as substantial staff furloughing schemes. Companies have also cut capital expenditure, but typically only moderately, and lower-rated companies have sharply cut M&A (although more highly rated companies have remained more active).

In spite of these efforts by companies in the sector, EBITDA margins eroded meaningfully across the following subsectors: catering, child care and education services, human resources and employment services, facilities installation and maintenance, and procurement and supply chain services. As a result, we took numerous rating actions between March 1, 2020, and March 1, 2021 (see chart 3).

Catering.  With most offices, schools, and sport facilities temporarily closed for several months due to lockdowns and strict social-distancing measures and canceled events, caterers providing on-site food services have been one of subsectors hardest hit by COVID-19. While certain key end-markets such as hospitals continued to remain open, it has been largely insufficient to offset the sharp general decline in revenue and EBITDA in end-markets subject to temporary closures. More than half of our global catering portfolio still has ratings with negative outlooks. Overall, we estimate that organic revenues declined between 30% and 70% in the second quarter of calendar-year 2020, with sharp declines in EBITDA for the same period. This is despite catering companies typically benefitting from a highly variable cost base (about 60% of total operating expenses are food and staff expenditures), contract flexibility with suppliers (with some contracts structures containing fixed fees), and generous government support measures in Europe (primarily employee furlough schemes). In most cases, we have altered our view from a swift recovery of credit measures once premises reopen to a phased and staggered return to 2019 revenue and EBITDA levels. Work-from-home initiatives are also dragging on performance, and we anticipate a recovery with capacity and activity back to pre-pandemic levels at the end of 2022, subject to improving lockdown conditions.

Child care and education services.  Educational providers that could quickly adapt to remote learning or are in attractive end-markets such as health care fared better than our issuers that are outside-the-home child care providers, which depended on premises remaining open. For example, technology-based educational, curriculum, and assessment solutions provider U.S.-based Ascend Learning LLC's operating performance was better than expectations, driven by strong demand in its clinical health care and fitness and wellness segments.

Child care center operators have been heavily affected by COVID-19-related shutdowns, social-distancing restrictions, and high unemployment rates. These include Bright Horizons Family Solutions LLC, KUEHG Corp., Learning Care Group (US) No. 2 Inc., Eagle Midco Ltd. (Busy Bees), and Babar Bidco SAS. We note that issuers with a portion of revenue derived from multiyear contractual arrangements with corporates (that pay a fixed annual fee) were more resilient but represent a minority of our rated portfolio. Revenue typically weakened by 25%-30% in 2020 relative to 2019.

Child care providers typically have relatively fixed cost bases. For instance, we understand that about 90% of France-based Babar BidCo's expenses are fixed, although revenue is also more resilient than peers' as it operates in highly subsidized countries. Many companies struggled to maintain adequate liquidity positions and were forced to negotiate with landlords to defer rent payments, seek covenant amendments, and raise debt. These issuers, all of which are speculative grade in our rated portfolio, were generally very highly leveraged before the pandemic hit. Nevertheless, most centers reopened by fourth-quarter 2020, and we expect all centers to be reopened by mid-2021. Utilization rates are improving each quarter with increased levels of government support, improved vaccination levels, and reduced restrictions, although we note that COVID-19 rates have picked up again in many European countries in recent weeks and could reverse this trend somewhat.

The longer-term risks for this sector remain elevated, in our view. As flexible work arrangements become increasingly common, volumes could weaken given changing consumer preferences and increased use of child care services in residential areas rather than corporate zones.

Human resources and employment services.  These providers are particularly sensitive to decreases in economic activity and employment levels. Across our rated staffing agencies, we have generally seen a sharp reduction in temporary staffing needs and hiring freezes across the board, from financial services hires to life sciences and health care staffing--with the latter falling in the first-half of 2020 as elective surgeries were postponed. This led to double-digit revenue declines and falling EBITDA in the first half of 2020.

Despite recovering business volumes across permanent and temporary positions, we anticipate a slow rebound. For example, for global workforce solution provider U.S.-based ManpowerGroup Inc. and Switzerland-based Adecco Group AG, we do not forecast a recovery in revenue to pre-pandemic levels in 2021. Nevertheless, the ratings impact has been limited given modest starting adjusted leverage, healthy liquidity positions, and solid covenant headroom.

Facilities installation and maintenance.  This subsector includes issuers providing HVAC (heating, ventilation, and air-conditioning) and other technical services. Although some issuers have been resilient, such as U.S.-based Refficiency Holdings LLC, with stronger top-line growth driven by COVID-19-related demand for air filtration services at mission-critical facilities (such as hospitals), most issuers will continue to take substantial hits to their top lines this year. For instance, for Sweden-based Assemblin, an electrical heating and ventilation service provider, we expect negative-to-flat organic growth in 2021.

Procurement and supply chain services.  This subsector serves many end-markets, with retail, energy, and discretionary-like segments hardest hit by the pandemic. For instance, credit metrics weakened for U.S.-based PSS Industrial Group Corp., a distributor of products supporting the energy sector, as clients conserved cash and refrained from capital investment. Others have fared better. Non-food procurement outsourcing company, U.K.-based Bunzl PLC, has outperformed our expectations, with high single-digit revenue growth in 2020. Bunzl saw heightened demand for COVID-19-related products such as personal protective equipment and hand sanitizer. More generally, this is a fragmented market and EBITDA margins are typically modest. High fixed costs have meant limited covenant headroom for some issuers (for example, contact lens distributor U.S.-based ABB/Con-Cise Optical Group LLC) and distressed exchanges (such as for CB Poly Investments, LLC).

Hygiene and facility management services.  Though cleaning and laundry facilities management services are largely nondiscretionary, lockdowns and social-distancing requirements took their toll on the sector. We note that U.S.-based coin-operated laundry service providers Spin Holdco Inc. and WASH Multifamily Acquisition Inc., with an exposure to multifamily housing, were not as affected as those with purely commercial exposures. Nevertheless, higher unit vacancy rates driven by the initial suburban flight resulted in mid-to-high double-digit declines in revenue and EBITDA year on year. More generally, lockdowns have hit the hospitality end-market hard, while issuers with health care end-markets, such as Italian-based Rekeep SpA, which provides surgical instrument sterilization among other services, performed better than we anticipated.

Our rated issuers in this subsector also include companies in facilities management, with a service offering ranging from car-parking management to landscape maintenance and repairs. The business impact across facilities management issuers has been varied. For instance, U.S.-based BrightView Landscapes LLC maintained high revenue retention rates despite COVID-19, highlighting the need for core maintenance services even though commercial real estate utilization remained low. On the other hand, Germany-based parking operator APCOA Parking Holdings GmbH faced double-digit revenue declines in 2020 as lockdowns affected volumes at the group's car parks.

Which subsectors will remain most robust in 2021?

The most resilient subsectors include brokerage and insurance services, testing, inspection and certification (TIC), information services, and some larger customer relationship management (CRM) outsourcers, classified within the customer engagement and acquisition subsector in table 1.

Corporate and legal services.  This subsector includes corporate and administrative services, such as the winding-up of legal structures for funds in the case of TMF Sapphire Midco B.V., and deposition and litigation services. COVID-19 resulted in court closures, leading in a fall in litigation-related spending and therefore revenue for our U.S.-based issuers operating in legal process outsourcing. Nevertheless, as the pandemic progressed and federal proceedings transitioned to remote platforms, issuers have adapted with quick cost-cutting actions and have seen a step-up in revenue that we expect to continue. Ratings on business services issuers operating in the legal segment, such as GI Revelation Acquisition LLC, currently carry a stable outlook as we expect financial performance to remain resilient over the next 12 months.

Security services.  This subsector includes staffed security, cash-in-transit, alarm monitoring, and prison operators. Allied Universal Topco LLC benefited from new COVID-19 screening services and lower wage pressures as unemployment rates increased. Additionally, a number of factors supported organic growth for some players: residential alarm providers benefited from lower attrition levels (as move-related disconnects declined), fiscal stimulus, the support of residential and commercial owners in paying their ongoing monitoring fees, and the increased deurbanization and work-from-home trends. These issuers, which typically generate relatively low free operating cash flow due to the large capital expenditures needed for customer acquisition, also recorded better cash flow dynamics as the industry adopted third-party financing models. That said, U.S.-based Monitronics International Inc. and 360Alert (Central Security Group Inc.) continue to face operating or liquidity challenges. On the cash-in-transit side, we have seen a mixed impact with cash collection and processing volumes in Latin America remaining strong, with those in Europe remaining slightly weaker than pre-pandemic levels.

Testing, inspection, and certification.  Although some of our issuers are exposed to cyclical end-markets in aerospace and oil and gas (like Element Materials Technology Ltd.), revenue across this subsector is largely recurring and driven by regulatory compliance needs. Their services are deemed to be mission critical and nondiscretionary, and often represent a very small proportion of the total spend of their clients' budgets. Given the complex nature of services provided, TIC employees are highly skilled and difficult to replace, and we therefore usually consider them as a fixed cost. However, government furlough schemes in the U.K., for example, have helped alleviate cost pressure somewhat. Furthermore, we note that in many instances TIC staff have been deemed essential workers and permitted to work throughout the pandemic.

Information services.  Issuers such as Experian Finance PLC, Fair Isaac Corp. (FICO), and CommerceHub Inc. typically capitalize on large datasets and analytics that support effective decision making and executed well in 2020. They also have solutions that are well integrated into their clients' workflow systems, and we continue to expect positive organic growth in this sector in 2021. Nevertheless, M&A activity has picked up, and debt-funded acquisitions (often with EBITDA multiples well above 20x) are likely to slow the pace of deleveraging.

Customer engagement and acquisition.  Within the outsourced customer relationship management (CRM) market, Europe-based Marnix French ParentCo SAS and Teleperformance SE have performed well. We noted diversification was a key indicator in differentiating issuer financial performance during COVID-19. Indeed, CRM operators with exposure to more mature telecommunication clients were typically more negatively affected than those focused on e-commerce and technology companies, which were helped by increased outsourcing. Niche CRM operators like Spain-based Giralda Holding Conexion S.L.U. (Konecta) displayed strong resilience, helped by solid client relationships. From an operational perspective, despite some initial concerns about the effect of remote working on call center customer experience and satisfaction, we have observed that many of our issuers successfully executed work-from-home workflows, which is likely to support future workforce flexibility and operating margins.

Consulting and other professional services.  Though we view consulting as a discretionary service, we expect client retention rates to remain stable and creditworthiness to remain robust in 2021. Revenue growth has broadly remained positive, with issuers offering countercyclical services, such as financial advisory and restructuring (for example, FTI Consulting Inc. and AlixPartners LLP), or with high exposure to digital and technology end-markets (like Castillon SAS). We have seen some margin erosion despite partner cuts and hiring freezes. This has been the case across our environmental consultancies with significant exposure to oil majors.

Brokerage and insurance services.  Our rated brokers and insurance servicers have demonstrated notable resiliency since the outset of COVID-19. Most insurance brokers (which comprise the majority of companies in the portfolio) closed out 2020 with flattish to slightly positive organic growth despite the macroeconomic headwinds, aided by relatively nondiscretionary and recurring core product offerings and benefits of insurance rate increases, which helped mitigate insured exposure declines. Margins also showed stability and in many cases strengthened for the brokers we rate, as these companies benefited from the self-correcting variable compensation lever, natural expense reductions in the COVID-19 environment from items such as lower travel and entertainment, and proactive expense management initiatives on discretionary line items.

Trends varied materially for the remainder of our insurance service companies given the portfolio diversity, with those most negatively affected consisting of our medical cost containment companies with revenue ties to elective health procedures and warranty administrators with revenue ties to light vehicle sales and consumer spending, some of whom demonstrated up to double-digit declines in the second quarter of 2020. Still, even these most affected issuers showed a notable rebound and material sequential improvement in the second half of the year given improving underlying trends such as a continued pickup in medical utilization and claims volume.

We expect all insurance service subsectors to demonstrate organic growth in 2021, supported by continued macro improvements and various new product development initiatives. For more information about this subsector, see "After Showcasing Resiliency During An Unprecedented Year, Global Insurance Brokers And Servicers Enter 2021 On Sound Footing," published on Jan. 28, 2021.

What accounts for recent defaults in the business services industry, and will they decline in 2021?

The business services sector already had weak average credit quality pre-pandemic, given a high percentage of private equity ownership, which tends to foster aggressive financial policies and highly leveraged balance sheets. The companies that recently defaulted typically operate in more cyclical end-markets hardest hit by travel restrictions, lockdowns, and social-distancing measures. Existing operational inefficiencies have been compounded by the pandemic and adverse end-market exposures. Given the high number of companies with low ratings across the portfolio, more defaults are likely in 2021, but we expect the default rate to reduce as the vaccine program is rolled out and the economy opens up again later this year.

Financial policy and stressed liquidity positions have also played a role in the increased default rate. In some instances, refinancing risk has accelerated the path to default, as was the case for U.S.-based home security and monitoring company Central Security Group, which was unable to repay its maturities coming due.

We also noted cases where issuers with relatively countercyclical business offerings defaulted. For instance, ASP MCS Acquisition Corp. (MCS). This is a U.S.-based provider of property maintenance services (for example, lawn maintenance, utilities management) for properties with mortgages that were defaulted on. As such, the group typically benefits from a countercyclical business model and records higher sales as unemployment and property vacancy rates increase. However, the group's financials did not materially improve during the pandemic given that a moratorium on eviction fillings came into force, preventing landlords from evicting residential tenants. We note that the group, which lost contracts in 2019 as banks decided to bring the services MCS offers in-house, historically had an unsustainable capital structure and weak liquidity. Indeed, the group was downgraded to 'CCC' in August 2019, before being downgraded to 'D' on a missed interest payment in June 2020.

Table 2

Though we have seen a drastic increase in the number of companies securing covenant waivers across the wider corporate universe, we have not observed a trend of that magnitude in the business services sector. For instance, in the U.S. since April 2020, we estimate that about 15% of U.S. loan issuers have relieved financial covenants (suspension and waiver periods) under their credit facilities, but we estimate this figure to be lower than 5% for our rated business services portfolio.

For the most part, we expect the anticipated recovery in end-markets to coincide with the expiry of covenant relief and step-downs in calculations. However, issuers facing slower recoveries could face further liquidity cliffs or be forced back to the negotiating table with their lenders in the coming months.

How has external support in the form of government support schemes helped to limit ratings downgrades?

Our European issuers have made wide use of COVID-19 support measures in the form of available government facilities and programs, in contrast to our larger issuers or financial sponsor-owned issuers in the U.S. that did not qualify for support programs. However, many U.S. issuers took advantage of deferred payroll tax payments that help support liquidity positions.

The implementation and extension of government employee support schemes, such as the employee furlough scheme in the U.K. and partial unemployment in France (where employees are paid a percentage of their gross salary), continue to benefit many business services companies. Staff costs are typically the biggest portion (typically up to 60%) of total operating costs. The use of government-backed debt funding in the U.K. (for example, the Bank of England's Covid Corporate Financing Facility) has been fairly limited within our rated portfolio. That's because issuers, particularly those with government contracts, have tried to show goodwill and resilience by not taking up these support measures when not required. However, many France-based issuers, especially those operating in CRM and business process outsourcing, have taken loans out through the PGE scheme (loans 70%-90% guaranteed by the French government). More generally, a vast majority of our issuers have also taken the options to delay VAT payments.

In the U.S., our issuers operating in the child care services sector benefited from reauthorization of the federal Child Care Development Block Grant. The provision of funds has lessened the impact of COVID-19 for child care operators throughout the U.S., which would have likely faced a period of cash burn during the first waves of the pandemic and subsequent lockdowns. We believe existing levels of support will continue and are likely to continue. That said, the direct use of government support across our wider U.S. portfolio has been limited, with little participation in the Payroll Protection Program. Nevertheless, the government has taken actions to prop up the economy through the CARES Act (stimulus bill), which arguably indirectly supported the creditworthiness of some of our issuers that are exposed to small to midsize enterprises.

What key risks remain? What shape will the recovery take?

Under our current base-case assumption that a vaccine or effective treatment will be widely available in third-quarter 2021 in most developed economies, we forecast a rebound of credit metrics in 2021 for most companies as lockdowns ease and contracts resume. However, there will be meaningful differences among subsectors, and we expect downside risks to remain, such as potential new COVID-19 variants, and continued economic headwinds.

Weaker real GDP and consumption growth than we currently expect.   Revenue in the business services segment is generally correlated with GDP. Under our base case, we expect real global economic growth to rebound to 5.6% in 2021, eurozone GDP to jump to 4.2%, U.S. GDP growth of 6.5%, and U.K. growth of 4.3%. However, the extent of a recovery will largely depend on how effectively vaccines are distributed where our issuers operate.

Increased bankruptcies that might lead to weaker growth as governments withdraw support measures.   As government support schemes unwind, EBITDA could erode significantly for issuers operating in markets that have not recovered. This could result in an increase in business bankruptcies and possibly an economic downturn.

Structural changes resulting from new working practices.   As working from home continues, employers will adopt more flexible permanent working solutions, resulting in a reduction in office space. Where contracts are based on square meters cleaned or are project-based, this could permanently lower revenue. We might see an impact to both higher value-added technical installation services and maintenance and lower value-added hygiene and facility management services. Additionally, a permanent change to consumer behavior, such as increased e-commerce, could hurt business service providers that support brick-and-mortar retailers.

Working capital reversals.   These are bolstering cash positions that continue to unwind for issuers experiencing reduced demand for their services. However, we view them as one-time positive effects that will delay pressure on liquidity for weaker entities. Adding to that pressure could be repayment of deferred payments originally due in 2020 for those companies returning to growth.

Inflation and pricing pressure.   Commoditized businesses such as security or facility services issuers could suffer from distressed competitors lowering prices or higher input costs, which would squeeze EBITDA margins.

Debt-servicing difficulties if operating conditions do not improve.   For our weakest issuers that have undergone distressed exchanges, we have often noted an alleviation of the interest burden when the company exchanges cash interest-paying debt instruments for payment-in-kind securities. We believe the existence of these high interest instruments and step-ups, though providing cash relief when servicing the debt, could pose challenges should a recovery fail to materialize or put pressure on the company when it eventually needs to recapitalize.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions 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.

Editor: Rose Marie Burke. Digital Designer: Joe Carrick-Varty.

Related Research

• After Showcasing Resiliency During An Unprecedented Year, Global Insurance Brokers And Servicers Enter 2021 On Sound Footing, Jan. 28, 2021
• COVID-19, Risks Of Global Recession Spike Business Services’ Downgrade Tilt, March 19, 2020
• Credit Conditions Europe Q2 2021: New Horizons, Old Risks, March 30. 2021