Key Takeaways
- S&P Global Ratings' value as a relative indicator of default risk is reflected in market pricing, which shows increased costs associated with lower ratings.
- Over the past 10 years, spreads on 'BBB-' rated debt have averaged 264 basis points (bps). That's lower than 334 bps for 'BB+' rated debt, but the relative increase in spread between the two is the highest of any adjacent pair.
- This jump in spreads was nudged higher during 2020, as the gap between the 'BB+' and 'BBB-' spreads rose to a record wide level last March.
- Spreads on debt with negative outlooks are wider than those on debt with stable or positive outlooks at the same rating. This reflects the value of our corporate rating outlooks as reliable indicators of relative downgrade potential.
Chart 1
S&P Global Ratings' credit ratings continue to correlate negatively with the cost of debt, meaning cost usually rises as ratings decline. Our corporate credit ratings are useful benchmarks in determining the margins over risk-free Treasuries that debt issuers pay to access the capital markets. This relationship holds up well historically (see chart 2).
Chart 2
Markets Price A Steep Premium On Spec-Grade In 2020
During the height of the pandemic and before the Federal Reserve (Fed) introduced $2.3 trillion of liquidity facilities on March 23, 2020, the difference between our 'BB+' and 'BBB-' corporates spreads hit a new high of 284 bps on March 27, 2020 (see chart 3). This "cost" of falling into speculative-grade, or becoming a fallen angel, did retreat during the summer of 2020. It was likely in large part because of the Fed's April 9 enhancement of the primary and secondary corporate liquidity facilities to include the debt of recent fallen angels.
So far in 2021, markets appear to have lower expectations for a large wave of fallen angels as the gap between 'BB+' and 'BBB-' returns to 97 bps on March 24, only slightly wider than the long-term average gap of 82 bps.
Chart 3
Fallen angel fears were heightened in 2020, even as the gap between the 'BBB-' and 'BBB' spreads hit a high not seen since the financial crisis. The relative proximity to speculative-grade may be lower at this rating level, but the potential for multi-notch downgrades was also likely a concern for the market in early 2020. In fact, roughly 30% of all global fallen angels in 2020 (38% in the U.S.) were a result of multi-notch downgrades, in a year that produced the fourth highest total of global fallen angels. Usurpingly, many of these multi-notch downgrades were issuers from sectors most affected by the economic lockdowns in 2020: airlines, oil and gas exploration and production, cruise lines, and hotels.
Rating Outlooks Provide Additional Signals
Our rating outlooks reflect our views on upgrade or downgrade potential for our current ratings. They also appear to provide additional valuable signals to market participants over time (see chart 4). Our negative outlooks reflect our expectations for a greater than 1/3 chance of a downgrade over the next 12 months for speculative-grade issuers, and over the next 24 months for investment-grade issuers. For bonds rated 'BBB-', those with a negative outlook typically trade with an additional 69 bps over those with a stable outlook, and an additional 112 bps over those with positive outlooks. These numbers speak to long-term trends, however, as chart 4 illustrates, this additional cost has been widening over time.
Chart 4
Similar patterns also hold for 'BB+' rated bonds (see chart 5). Those with a negative outlook carry, on average, an additional 102 bps over those with a stable outlook; and are, on average, 156 bps over those with a positive outlook.
Rising stars had an annual low in 2020, with only seven globally (four in the U.S.). Rising stars are speculative-grade issuers upgraded to investment-grade. However, with an improving economic outlook in the U.S. for 2021, recent pricing of 'BB+' bonds with a positive outlook has become tighter relative to those with either a stable or negative outlook since the end of the third quarter of 2020. This may reflect market participants' expectations for increased rising star activity in 2021
Chart 5
Related Research
- ‘BBB' Pulse: Fallen Angel Downgrade Risk Is Set To Decline Sharply In 2021, April 14, 2021
- 'BBB' Pulse: Cautious Optimism Grows With No Fallen Angels And Three Rising Stars In January , Feb. 19, 2021
- The Cost Of A Notch, March 26, 2019
This report does not constitute a rating action.
| Ratings Performance Analytics: | Nick W Kraemer, FRM, New York + 1 (212) 438 1698; nick.kraemer@spglobal.com |
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