This year's economic rebound, improving business conditions, and favorable financing conditions are benefiting nonfinancial companies rated in the 'BBB' category by S&P Global Ratings in the U.S. and Europe, the Middle East, and Africa (EMEA). Rising stars (issuers upgraded to investment-grade ['BBB-' or higher] from speculative-grade ['BB+' or lower]) are outnumbering fallen angels (issuers downgraded to speculative-grade from investment-grade) in 2021. There were only two fallen angels by the end of February, both from sectors under pressure: oil and gas and aerospace/defense. Meanwhile, there were five rising stars.

We expect fallen angel debt to be lower in 2021 than in 2020 as the number of potential fallen angels (issuers rated 'BBB-' with negative outlooks or ratings on CreditWatch with negative implications) continues declining and as the recovery gains momentum in many sectors (see chart 1). However, even as business conditions are improving, companies' financial policies will largely determine how long it takes for credit metrics to return to pre-pandemic levels. With capital markets offering ample liquidity and low funding costs for 'BBB' category rated issuers, aggressive financial policies, such as those that benefit shareholders at the expense of creditors, could delay recovery.

Chart 1

Fallen Angel Debt Is Projected To Fall To $195 Billion

For our hypothetical scenario in this report, we estimated the amount of long-term nonfinancial corporate 'BBB' category rated debt vulnerable to downgrade to speculative-grade in the U.S. and EMEA by assigning fallen angel probabilities to each rating and outlook or CreditWatch combination as of Feb. 28, 2021. These hypothetical relative probabilities and the approach used to generate the estimates are summarized in table 5 in the appendix. The estimated results were as follows:

• For the U.S., roughly $130 billion, or about 4.2% of the outstanding total long-term 'BBB' debt on Feb. 28, is vulnerable to downgrade to speculative-grade in 2021.
• In EMEA, the equivalent figures are $65 billion and 2.8%.
• Combined, approximately $195 billion in 'BBB' debt could fall to speculative-grade through 2021--representing about 3.6% of total 'BBB' long-term debt in the U.S. and EMEA.

As the economic recovery takes shape, the amount of debt we estimate will fall to speculative-grade in 2021 has declined for both the U.S. and EMEA since our estimate from December. Sector forecasts have improved as vaccines roll out, while fiscal and monetary stimulus in the U.S. and Europe are bolstering the economic rebound. Although the amount of 'BBB' debt has increased by 4% since the beginning of December, the number of potential fallen angels and their associated debt continue to decline. While we expect $195 billion in fallen angel downgrades in 2021, fallen angel debt totaled just $9.1 billion in the U.S. and EMEA through the first quarter.

The Rising Stars Of The Recovery Emerge

More issuers are becoming rising stars as the post-pandemic recovery takes shape. Five nonfinancial issuers in the U.S. and EMEA were upgraded to investment-grade in the first two months of 2021, compared with just two issuers downgraded to speculative-grade. Three of these rising stars were upgraded after mergers or acquisitions, while the other two resulted from improved expectations for revenue or financial policies. Through February, rising star debt totaled $38.5 billion, already bringing 2021's total in excess of 2020's full-year total (see chart 2).

Furthermore, at the end of February, there remained 12 potential rising stars within the U.S. and EMEA, signaling further positive momentum.

Chart 2

Potential Fallen Angel Debt Is Shrinking

The amount of 'BBB' category debt that is most vulnerable to downgrade to speculative-grade has declined over the past six months (see chart 3). Nonfinancial potential fallen angel debt from the U.S. and EMEA declined to $296 billion (55 issuers) as of Feb. 28, 2021, from a peak of $375 billion (69 issuers) as of Aug. 31, 2020--a 19% drop.

Chart 3

Much of the decline is attributable to outlook revisions to stable in sectors that are faring better than expected or that stand to benefit from the emerging recovery (see chart 4). The sectors with the largest improvements in potential fallen angel debt over the past six months were oil and gas and midstream, consumer products, automotive, and metals and mining. In the retail and restaurants sector, the amount of potential fallen angel debt also declined, but the picture is mixed, with mall-based retailers and in-person dining facing longer roads to recovery.

Meanwhile, the amount of potential fallen angel debt remained elevated for the transportation, aerospace, and media and entertainment sectors.

Chart 4

Oil and gas

Oil and gas prices have recovered thanks largely to significant OPEC and Russian supply cuts and global stimulus policies that have improved demand and the economic outlook. In March 2021, S&P Global Ratings raised its price assumptions for Brent and West Texas Intermediate crude oil for the remainder of 2021 and 2022. We believe the prices in the current deck will support the credit quality of many of the issuers we rate, including the 'BBB-' issuer credit ratings and stable outlooks on former potential fallen angels Cimarex Energy Co., Devon Energy Corp., Diamondback Energy Inc., and Marathon Oil Corp.

Consumer products

While performance in the consumer products sector remains bifurcated, with essential products and home decor faring much better than work apparel and consumer durables, potential fallen angel debt for the sector has declined over the past six months. The improvement largely resulted from Sysco Corp. moving off the list of potential fallen angels after we revised the outlook to stable from negative. We expect demand for food service will improve and industry sales will recover close to pre-coronavirus levels over the next one to two years, while Sysco will gain share and reduce leverage.

Auto

In the automotive sector, a merger between Peugeot and Fiat Chrysler Automobiles N.V. (FCA) resulted in the new company Stellantis N.V. (BBB-/Stable/A-3). The rating reflects our view that increased scale and diversity are positive elements in the auto industry and that the combined entity has a solid balance sheet and good free cash flow prospects. Before the merger, Peugeot was a potential fallen angel and FCA was a potential rising star (an issuer rated 'BB+' with a positive outlook or on CreditWatch with positive implications).

Metals and mining

Prices for most metals have shot up since mid-2020 even as China's stimulus-led reopening resulted in full-year domestic steel output reaching a record 1.05 billion tons in 2020 amid robust domestic demand. We expect momentum to continue as the economic recovery in Asia-Pacific and global vaccine progress fuel optimism for a fast market recovery, barring further widespread and extended lockdowns. This would provide underlying support for global commodity prices and accelerate the recovery path for the metals and mining sector.

In February 2021, we removed ArcelorMittal from the potential fallen angel list after revising the outlook to stable from negative on significant growth in demand for steel and high prices for iron ore, which are driving stronger performance for the company.

Retail and restaurants

The outlook for retail and restaurants, as with consumer products, remains mixed, with a longer recovery envisioned for mall-based retailers and in-restaurant dining. Some areas of retail and restaurants that benefit from COVID-19 trends, such as home improvement, leisure apparel, online shopping, and fast-casual dining, have fared much better.

While potential fallen angel debt for the sector has declined over the past six months, that picture is also mixed: We removed Nordstrom Inc. from our list of potential fallen angels when it became a fallen angel in September 2020 (downgraded to 'BB+') as a result of accelerating secular changes that we believed would have lasting damaging effects on the U.S.-based department store retailer. On the other hand, we revised our outlook on grocer Auchan Holding S.A. to stable from negative in November 2020 based on our expectation that the company would use asset-disposal proceeds to restore its financial capacity and focus on turning around its western European retail operations.

Media and entertainment, transportation, and aerospace

In sectors like media and entertainment (which includes leisure), transportation, and aerospace, the path to recovery is still uncertain because of the uneven rollout of vaccines in different regions and some permanent shifts in consumers' behavior. In Europe and North America, the majority of media and entertainment ratings in the 'BBB' category are assigned negative outlooks, and new, prolonged sector difficulties could trigger negative rating actions.

Meanwhile, the transportation sector has already taken a severe hit, with a few fallen angels coming from this industry in 2020 (for example, British Airways PLC and Deutsche Lufthansa AG) and the remaining companies in the 'BBB' category (for example, easyJet PLC and Ryanair) expected to experience a slow recovery. We forecast the airlines and airport sector will recover to 2019 levels after 2023.

The Boeing Co. remains the largest overall potential fallen angel (see chart 5). Boeing completed a $9.8 billion bond offering in early February, which has allowed the company to maintain a large liquidity cushion as it refinances a portion of its $13.8 billion term loan maturing next year.

Chart 5

Sectors With The Most 'BBB' Debt Are On Track For Near-Term Recovery

Although potential fallen angels show the highest risk of downgrade to speculative-grade, these issuers account for a minor share (near 5%) of total 'BBB' debt. Nonfinancial companies in the U.S. and EMEA rated in the 'BBB' category have nearly $5.4 trillion in debt outstanding (as of Feb. 28). Nearly half of this debt is from issuers in sectors either where credit quality was unaffected by the COVID-19 pandemic or that are expected to recover to their pre-pandemic credit metrics by the end of 2022 (see chart 6). Just 16% of the 'BBB' category debt is from companies in the sectors that remain most affected by the pandemic, with credit metrics not expected to recover before 2023 or later.

Chart 6

The sectors that account for the greatest concentration of 'BBB' debt remain on track to regain their credit metrics to pre-COVID-19 levels, and the pace of recovery will likely increase for many companies as the economic recovery and widespread vaccinations alleviate downside risk (see chart 7).

Chart 7

Financial Policies Come Into Focus As The Recovery Becomes Clearer

The telecommunications sector accounts for the largest amount of 'BBB' category debt, with more than $850 billion (just 14% of which is 'BBB-'). This sector proved resilient in 2020, benefiting from the increased necessity of mobile and broadband services. While we expect the sector to regain its pre-2020 credit metrics in the first half of 2021 in the U.S. and in 2022 for EMEA, financial policy decisions remain a critical factor in the shape of the recovery.

We recently revised the outlooks to negative for two of the sector's largest 'BBB' category rated companies, AT&T Inc. (BBB/Negative/A-2) and Verizon Communications Inc. (BBB+/Stable/A-2), after bidding in the C-Band auction surpassed our estimates by a substantial margin. While the acquisition of licenses in the auction will improve AT&T's and Verizon's competitive positions, it also results in higher-than-expected leverage.

The consumer products sector has the second-largest amount of 'BBB' category debt (less than 13% of which is 'BBB-'). Within the sector, providers of consumer staples, such as packaged and branded food and personal and home care, have either seen no deterioration due to the pandemic or are expected to recover in the first half of 2021. Meanwhile, we do not expect producers of luxury and discretionary goods to return to their pre-2020 credit metrics before 2023. This sector also includes business services, for which the decline and recovery in companies' performance and credit metrics depend on the nature of the services; the essential ones have not experienced deterioration.

As in other sectors, financial policy decisions will help determine when consumer products companies will recover to pre-COVID-19 credit metrics. One of the recent rising stars from this sector, Smurfit Kappa Group PLC, was upgraded to the 'BBB' category in February on its tighter financial policy after the group raised equity in November to repay debt and fund future investments.

Improvement Is Expected This Year For 'BBB' Leverage Metrics

With the recovery taking hold in many of the sectors with the greatest concentration of 'BBB' debt, the downgrade rates of 'BBB' category issuers have begun to decline from their highs in fourth-quarter 2020 (see chart 8).

Chart 8

Favorable credit market conditions fueled increasing mergers and acquisitions (M&A) and leverage for years prior to the pandemic. We expect the average leverage ratio to improve in 2021, but performance will be uneven among sectors. We assume the recovery will be gradual, and it may take until 2023 and beyond until all sectors recover to pre-COVID-19 credit metrics. Financial policy decisions may keep leverage elevated as a result of M&A and shareholder returns.

We expect median debt to EBITDA for publicly rated 'BBB' nonfinancial corporate issuers in the U.S. and EMEA to fall to 3.05x in 2021. This will be an improvement from 3.3x in 2020 and fall slightly below 2019's level (see chart 9). Meanwhile, the median EBIT interest coverage for 'BBB' nonfinancial companies is expected to rebound to 4.7x, slightly above 2019's level, later this year (see chart 10).

Chart 9

Chart 10

'BBB' Financing Conditions Remain Resilient

The amount of 'BBB' debt has grown by about 4%, to $5.4 trillion as of Feb. 28, 2021, from $5.2 trillion on Oct. 31, 2020. This growth follows the upgrades of recent rising stars, including Fiat Chrysler Automobiles N.V. (now Stellantis N.V.) and WPX Energy Inc. Furthermore, the downgrades of a few issuers from the 'A' category, including The Walt Disney Co., Duke Energy, and National Grid PLC, have contributed to the growth of 'BBB' debt.

Beyond these recent additions, the volume of 'BBB' debt continues to grow as accommodative financing conditions and low funding costs support elevated issuance volumes. Last year saw record debt issuance as bond markets received significant support from major central banks, particularly the Federal Reserve and the European Central Bank. Besides keeping rates at record lows across the yield curve, these central banks have enacted a number of unconventional easing policies, including direct purchases of investment-grade corporate bonds on both the primary and secondary markets. These measures combined have helped restore market confidence, kept borrowing costs low, and spurred primary market activity (see charts 11 and 12).

As the gradual economic recovery continues, bond issuance has so far remained strong. Though it remains to be seen how much of the extraordinary issuance activity in the second half of 2020 will persist this year, the first two months of 2021 saw more fundraising in the bond markets than in the same period a year ago, and 'BBB' issuance grew quarter on quarter in the first quarter.

Chart 11

Chart 12

Corporate funding remains cheap for the 'BBB' category, despite the recent uptrend in the benchmark 10-year U.S. Treasury rates as part of the "reflation trade," wherein markets begin to expect the Fed to raise rates sooner than previously thought based on the size of fiscal stimulus. Growing concerns about U.S. inflation have yet to dampen financing conditions for 'BBB' issuers. Yields of newly issued 'BBB' bonds in the first quarter of 2021 have held near 2.2%, basically unchanged from their average in fourth-quarter 2020 despite the increase in U.S. Treasury yields (see chart 13).

Chart 13

The recent increase in U.S. Treasury yields has been mitigated somewhat by compression of 'BBB' credit spreads in the secondary market. Indeed, secondary market yields for 'BBB' corporates remain close to all-time lows, with the composite U.S. corporate 'BBB' 10-year spread narrowing by 11 basis points (bps) year to date, to 130 bps as of Feb. 28, 2021. This spread is back near its record lows from 2018 (see chart 14). Even with a 41 bps increase in January and February, secondary market yields also remain near historic lows for 'BBB' bonds (see chart 15).

Chart 14

Chart 15

Meanwhile, the cost of a downgrade to speculative-grade continues to decline. We measure this as the 22-day moving average of the difference between U.S. corporate 'BBB-' and 'BB+' spreads, which has fallen to less than 90 bps as of March 8, 2021 (see chart 16). While this cost of a notch is higher than the 0-50 bps average in 2018, it remains far below the peak of 241 bps in April 2020.

Chart 16

Will Financial Policies Remain Conservative?

With the capital markets offering low financing costs and ample liquidity, and the cost of a notch between investment- and speculative-grade narrowing, it's unclear how long financial policies for the hardest-hit sectors will remain conservative and focused on reducing debt loads that became elevated over the past year. A delay in recovery could be most problematic for these sectors, which are expected to take several years to recover.

In some sectors, share buyback activity is also resuming, with 'BBB' category issuers including home improvement retailer Lowe's Cos. Inc., residential real estate company Grand City Properties S.A., and property developer CPI Property Group S.A. announcing share buybacks in the first quarter of 2021.

Furthermore, a loosening of financial discipline could lead to further downgrades. For instance, we downgraded Host Hotels & Resort Inc. to 'BB+' with a negative outlook after it announced that its large cash balances were a strategic advantage in making opportunistic acquisitions--in a hotel transaction market where opportunities are increasing despite revenue per available room remaining well below pre-COVID-19 levels.

Appendix 1: Global Potential Fallen Angels And Rising Stars

This year began with rising stars outnumbering fallen angels in the first two months. Potential rising stars and fallen angels have also continued to see positive trends since the start of 2021. Some weaker firms have benefited from merging with or being acquired by stronger ones, while other firms in certain sectors should begin to see better credit metrics as the gradual economic recovery presses on.

While there were two fallen angels in the first two months of 2021, the count of potential fallen angels continues to decrease, with 95 remaining globally (see chart 17). So far this year, there have been five additions and nine removals from the global potential fallen angels list. Most of the additions were based on idiosyncratic factors, while the removals have mostly been due to improving outlooks, better-than-expected performance, or M&A.

Chart 17

At the end of February, there were 13 potential rising stars globally, mostly in real estate, metals and mining, or financial institutions. While this is slightly down from 17 at the beginning of the year, the pool of potential rising stars remains considerably larger than it was for much of 2020, and the recent uptick in rising stars suggests further improvement.

Table 1

Table 2

Table 3

Table 4

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.

Appendix 2: Hypothetical Scenario Analysis Approach And Additional Information

This hypothetical scenario analysis included parent firms in the U.S. and EMEA rated in the 'BBB' category and all qualifying debt in their organizational hierarchies, as well as the qualifying debt of subsidiaries rated in the 'BBB' category, if their parents are assigned other ratings. Reported debt included both secured and unsecured bank loans, subordinated debt, medium-term notes, preferred stock, convertible debt, and drawdowns under medium-term note programs. It did not include commercial paper programs, shelf registrations, revolvers, or certificates of deposit.

The hypothetical risk weights for the stable outlooks in table 5 approximate the relative long-term fallen angel rates in the U.S. and EMEA regions combined over a 12-month rolling horizon from 2010 through 2020.

Table 5

The risk weights applied to the negative and positive outlooks and CreditWatch statuses represent estimates for fallen angel potential given the current economic conditions--with far more fallen angel risk among companies rated 'BBB-' and on CreditWatch with negative implications, and essentially no fallen angel risk for companies rated 'BBB+' with positive outlooks. We then multiplied the debt distribution by each corresponding risk weight in this scenario and summed the total. We used this to calculate a hypothetical downgraded debt amount through the end of 2021.

Table 6

Table 7

Table 8

Table 9

Table 10

Related Research

• The Cost Of A Notch: During COVID-19, The Cost Of Falling To Speculative-Grade Reached A New High, April 14, 2021
• COVID-19 Heat Map: Some Bright Spots In Recovery Amid Signs Of Stability, Feb. 17, 2021
• 'BBB' Pulse: Fallen Angels Should Remain Elevated As COVID-19 Cases Rise, Dec. 2, 2020