Key Takeaways
- S&P Global Ratings plans to introduce alpha-numerical ESG Credit Indicators starting from September 2021. Our aim is to add transparency and help explain the influence of ESG factors on our credit rating analysis.
- We have just released a series of ESG industry report cards for structured finance. Auto- and commercial mortgage asset-backed securities have above average environmental exposure. We see social risks as above average for credit-card and residential mortgage asset-backed securities.
- ESG-related rating actions over the first quarter edged up to 201 (83 in March), of which 126 were downgrades (51 in March). About 60% of actions are health-and-safety related (social), stemming from direct effects of the pandemic; 30% are related to environmental influence and 10% to governance.
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Table 1
| ESG-Related Rating Actions (January-March 2021) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Sovereigns | International public finance | U.S. public finance | Corporates and infrastructure | Structured finance | Total | |||||||||
| Downgrade | 5 | 6 | 19 | 34 | 62 | 126 | ||||||||
| CreditWatch negative | 0 | 0 | 22 | 14 | 10 | 46 | ||||||||
| Downward outlook revision | 1 | 1 | 8 | 8 | 0 | 18 | ||||||||
| Upgrade/Upward outlook revision | 0 | 0 | 1 | 10 | 0 | 11 | ||||||||
| Total ESG-related rating actions* | 6 | 7 | 50 | 66 | 72 | 201 | ||||||||
| Of which social§ | 6 | 6 | 12 | 38 | 63 | 125 | ||||||||
| Of which governance§ | 0 | 1 | 15 | 6 | 0 | 22 | ||||||||
| Of which environmental§ | 0 | 0 | 32 | 22 | 9 | 63 | ||||||||
| *Rating actions comprise rating, CreditWatch, and Outlook changes over January-March 2021. Since March 30, 2020, S&P Global Ratings references in its press releases when rating changes have been influenced by ESG factors. §The sum of social, governance and environmental actions exceed total ESG rating actions because some actions were influenced by multiple factors. | ||||||||||||||
S&P Global Ratings proposes additional transparency on ESG factors as drivers of credit ratings
Currently we include qualitative ESG insights in many of our credit rating reports. To supplement this, we intend to introduce alpha-numerical ESG Credit Indicators (see below example) to further help explain the influence of ESG factors on our credit rating analysis. Over time, but not before September 2021, we would begin to publish ESG Credit Indicators for rated entities and, where relevant, at the transaction level.
Importantly, such ESG Credit Indicators will not affect our credit ratings because they do not belong to our credit rating methodologies. Instead, they will reflect our qualitative assessment--determined during a rating review, typically by a rating committee--about whether ESG factors have a neutral, positive, or negative influence on the key components of our credit rating analysis specific to each entity or transaction.
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Spotlight on ESG in Structured Finance
Our credit ratings on structured finance transactions incorporate ESG credit factors when they could affect the likelihood of timely payment of interest or ultimate repayment of principal by the legal final maturity date of the securities and may be more material for some tranches than others depending on the rating level, time horizon, and available structural mitigants. This differs from our ESG approach to issuer credit ratings that we assign to corporates and sovereigns.
We have just published ESG industry report cards on various asset classes (see "ESG Industry Report Cards For Structured Finance Published, March 31, 2021) outlining the relative gross sector exposures (average, below average, above average) to ESG credit factors (see table).
Table 2
| ESG Exposure In Structured Finance By Sector | |||
|---|---|---|---|
| Classification | |||
| Sector | Environmental | Social | Governance |
| Auto asset-backed securities | Above average | Average | Below average |
| Credit card asset-backed securities | Below average | Above average | Average |
| Student loans asset backed securities | Below average | Average | Below average |
| Residential mortgage-backed securities | Average | Above average | Below average |
| Commercial mortgage-backed securities | Above average | Average | Average |
| Collateralized loan obligations | Below average | Below average | Average |
We highlight the following areas with above average exposures:
- Auto ABS: Greenhouse gas emissions, with numerous jurisdictions having announced plans to phase out ICE engines. This could result in lower collateral values over time, affecting recoveries and residual values.
- CMBS: We view CMBS pools as more concentrated than other highly diversified asset classes in structured finance, and environmental risks can have serious and material effects on the value of commercial real estate.
- RMBS: Housing is one of the most basic human needs, with regulators increasingly focused on ensuring fair treatment of borrowers, predominately retail ones. Aggressive collection practices or failure to underwrite in accordance with applicable regulations would increase legal and regulatory risks. In our view, social risks would be relatively higher for nonprime borrowers given affordability considerations.
- Credit card ABS: Regulators in many jurisdictions are increasingly focused on credit products with relatively high borrowing costs, and ensuring that lenders are considering the borrower's affordability in their underwriting and ongoing management of revolving credit lines.
- In our view, social risks would be relatively higher for subprime borrowers given affordability considerations.
In our published rating rationales, we intend to include a dedicated ESG paragraph comparing the transaction to our ESG sector benchmark (where applicable), while identifying the relative ESG risks and opportunities and any structural mitigants to these risks. Through this narrative we aim to add transparency on how our rating analysis has accounted for specific ESG credit factors.
The biodiversity crisis is a still-nascent ESG consideration but climbing up the agenda
Climate change and biodiversity loss are interlinked, but solutions to reduce gas emissions are unlikely to benefit biodiversity in the same way. Though natural capital and biodiversity is creeping up the agenda, climate change dominates. Maybe this is because of the current absence of direct and material financial ties to nature.
That said, the World Economic Forum estimates that more than half the world's GDP is moderately or highly dependent on nature and its services. Terrestrial biodiversity loss is tied to three consumer staples: palm oil, beef, and soy. These soft commodities are responsible for around 70%-80% of the 10 million hectares of natural habitat that the UN Food and Agriculture Organization estimates is lost to deforestation globally each year.
Professor Sir Partha Dasgupta (University of Cambridge) explains in his recent review that "sustainable economic growth requires a different measure than gross domestic product." He says we should adopt not just a flow (GDP) but also a stock approach to wealth--one that considers the aggregate value of all capital assets--to take our use of natural capital into account.
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The article by S&P Global Ratings' Sustainable Finance team, "Environmental, Social, And Governance: Natural Capital And Biodiversity: Reinforcing Nature As An Asset," was published April 12, 2021.
Sectors Overview
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Sovereigns And International Public Finance
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See here for a list of all rating actions in this sector.
Sovereign rating actions continue to be driven by fiscal and economic fallouts from the pandemic, which we consider a health and safety credit factor. For example, on March 5, 2021, we lowered the long-term credit ratings on Kenya to 'B' from 'B+', due to a sharp slowdown in GDP growth in 2020 tied to the pandemic and a consequent rise in fiscal deficits. We estimate that the pandemic-related economic fallout drove Kenya's real GDP growth down to 0.2% in 2020 from an average of 5.6% in the previous five years. The economic shock also widened Kenya's fiscal deficits and will weigh on its already weak public finances and external debt metrics.
U.S. Public Finance
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See here for a list of all rating actions in this sector
U.S. public finance ESG-driven rating actions in March primarily reflected ongoing credit deterioration of Texas' public power and electric cooperative not-for-profit utilities following Winter Storm Uri. U.S. public finance took 35 rating actions in March driven by ESG factors, of which 21 were associated with rating reviews of Texas public power and electric cooperative not-for-profit utilities. Our evaluation of environmental and governance risks exacerbated by the February storm led to additional downgrades. The knock-on credit effects of the storm and the consequent liquidity and financial pressures for these utilities may not be over; many ratings remain on CreditWatch negative (see "Winter Storm in Texas Will Continue To Be Felt In Utilities' Credit Profiles," published March 15, 2021.
Elevated governance risks also contributed to our rating actions on two not-for-profit health care institutions: Kuakini Health System in Hawaii and Tower Health in Pennsylvania. We lowered our ratings on each institution by two notches, to 'CCC' and 'BB-' respectively. An inability to manage risk and execute strategic initiatives to shore up operational pressures contributed to the downgrades.
Case Study: Kuakini Health System, HI 2002A Revenue Bond Rating Cut To 'CCC' On Rapid Cash Deterioration, March 25, 2021
The lower rating reflects Kuakini's rapid earnings and cash deterioration this past year. In addition, the rating action is also driven by our view of increased governance risks due to leadership's inability to achieve sustainable operations in recent years and effectively adjust the organization's strategy such that operating earnings sufficiently cover debt service and support the hospital's mission and longer-term viability.
Management has consistently expressed its desire to remain independent despite broad sector pressures continuing to foster a precarious financial situation at the hospital, with a recent reliance on donations and foundation transfers to subsidize clinical operations. Finally, we note that interim fiscal 2021 losses through Dec. 31, 2020, are technically ahead of budget, despite contributing to immense balance sheet weakening and negative cash flow. We believe this is indictive of weaker operational effectiveness and a factor supporting the downgrade and our view of heightened governance risk.
Environmental, social, and governance (ESG) credit factors for this credit rating change:
- Strategy, Execution, and Monitoring (Governance)
Corporates And Infrastructure
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See here for a list of all rating actions in this sector
Since the end of 2020, ESG-related actions have moderated to about 20 actions per month. Despite some impending relief regarding social distancing and other restrictions as vaccines become more available, recovery rates vary, and we have seen virus spikes in different regions across the globe.
Health and safety factors related to the pandemic still accounted for 70% of actions in March 2021, with most actions in the hospitality and real estate sectors. For instance, we lowered our ratings on MGM Resorts International, Marriott Vacations Worldwide Corporation, and Host Hotels & Resorts Inc. given the anticipated slow recovery of the travel sector. We also took negative rating actions on several U.S. real estate companies; we downgraded Vornado Realty Trust (to 'BBB-' from 'BBB') and Washington Prime Group Inc. (to 'D' from 'CC' following a missed interest payment) as credit metrics weakened amid uncollected rents, deferrals, and/or abatements resulting from the pandemic. We revised our outlook to negative on SL Green Realty Corp. given the potential for a decline in office space demand as companies rethink their needs. We revised our outlook on Federal Realty Investment Trust to negative in part because of retail tenant distress caused by the pandemic. We downgraded Mexico-based real estate developer and operator GICSA to 'B+' because the pandemic has dented rental income from its malls and office tenants, as well as the sale of its residential project, which ultimately weakened GICSA's liquidity position. We expect GICSA's liquidity position and financial performance to remain vulnerable to lockdowns for most of 2021 given the slow vaccine rollout in Mexico.
U.S. private prison operators are exposed to ongoing social and governance risks as they are often criticized for various human rights issues. These include confinement practices, prisoner violence, and mistreatment. CoreCivic Inc. and The Geo Group, Inc. incurred ratings downgrades following President Biden's Executive Order to The U.S. Department of Justice (DOJ) to not renew contracts with privately operated criminal detention facilities.
Our three-notch governance-related downgrade of U.K. oil service provider Petrofac to 'B+' shows the risk of long-lasting reputational consequences of bribery events. This relates to corrupted payments allegedly offered in 2013-2014 by a Petrofac employee. The U.K. Serious Fraud Office's investigation started in May 2017 and is ongoing. The UAE's ADNOC recently suspended Petrofac from bidding for new contracts; Saudi Aramco had already done so in 2019.
Case study: CoreCivic Inc. Downgraded To 'BB-' On Heightened Business Risk; Outlook Negative; March 24, 2021
On Jan. 26, 2021, President Biden instructed The U.S. Department of Justice (DOJ) to not renew contracts with privately operated criminal detention facilities (e.g., prison operators). DOJ contracts with CoreCivic Inc. accounted for about 24% of 2020 revenue. We have lowered our assessment of CoreCivic's business profile to weak.
In our view, the use of U.S. privately operated criminal detention facilities is at a crossroad. Unless various political constituents agree on a common policy framework or guidelines for the use of these government service providers, which we don't expect in the coming years, industry participants will face uncertain operating conditions. We expect increasingly volatile earnings, or lower financing availability as the weight of changing political administrations, rhetoric, and environmental social and governance (ESG) mandates impact business prospects. CoreCivic is exposed to the risk of public policy change or increased insourcing risk (e.g., a similar executive order is issued to the U.S. Immigration and Customs Enforcement (ICE) agency, or criminal justice reform results in a sharp reduction in inmate populations). CoreCivic has significant revenue concentration with the top 5 federal agencies and state governments accounting for about 66% of 2020 revenue.
Environmental, social, and governance (ESG) credit factors for this credit rating change:
- Health and safety
Case study: Petrofac Ltd. Rating Lowered To 'B+' From 'BB+', Put On CreditWatch Developing, Withdrawn At The Company's Request, March 29, 2021
The downgrade follows the UAE's ADNOC Group's announcement on March 15 that it had suspended Petrofac from bidding for new awards until further notice. The timing of the announcement--during challenging conditions for oil and gas (O&G) contractors, the current refinancing of Petrofac's $1 billion revolving credit facility (RCF), and the continuing U.K. Serious Fraud Office (SFO) investigation--led us to lower our rating on Petrofac to 'B+'.
We've reassessed Petrofac's business risk profile as weak, as its position in its core Middle East market has deteriorated, as the suspension in the UAE, after a previous bidding suspension by Saudi Arabia in early 2019, will likely require Petrofac to divert its bidding efforts to other regions.
We understand that the SFO remains in an investigatory phase and has raised no allegations against Petrofac. We further understand that the investigation could indicate some past deficiencies in Petrofac's internal controls that may have contributed to changes in its business strategy, as mentioned in our previous publications addressing the SFO's investigation. Our governance reassessment also took into account the resignation of Petrofac's founder and long-standing CEO.
Environmental, social, and governance (ESG) credit factors for this credit rating change:
- Governance – Risk management and internal control factors.
Financial Services
Financial services ratings have experienced very few ESG-related impacts over the past 12 months. Over the past year, the banking and insurance sectors have seen hardly any rating or outlook changes directly attributable to ESG factors. The ESG trends we see as most relevant for financial services companies, and which are growing in momentum, are tackling climate change and the standardization of ESG reporting. As many countries target a green recovery post-COVID-19, banks and insurers have an opportunity to support this with regards to the way they allocate capital through lending, investing, or underwriting. This presents opportunities for growth and returns, but also poses challenges as firms look to manage their exposures to climate risks throughout their value chains. However, because banks and insurers are often dependent on the quality of disclosure from their underlying counterparties (for example, borrowers, policyholders, or investee companies), their ability to reliably assess their own exposures can be affected if there are gaps in the underlying data.
Structured Finance
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See here for a list of all rating actions in this sector.
Commercial mortgage-backed securities (CMBS) remains the most affected sector in term of health and safety factors related to COVID-19, with a total of 21 ESG-related rating actions in March. Amid renewed waves of COVID-19 infections and the spread of new variants, social-distancing restrictions continue to weigh on the revenues and credit profile of properties that back loans in CMBS, such as shopping centers.
Credit FAQ: How Will The Recent Floods Affect Australian RMBS?, March 31, 2021
Mortgage arrears are likely to rise in communities on the east coast of Australia affected by recent floods. The government has declared a natural disaster in several areas of New South Wales in response to torrential rains and historic flooding, and flood warnings remain current in Queensland. We estimate that exposure to areas where floods have been most severe is less than 7% across the broader Australian RMBS sector, and fewer than 10 RMBS transactions out of our rated pool of around 260 have a high exposure to nonmetropolitan areas in New South Wales, where flooding has been more severe.
This could lead to debt-serviceability pressures for affected borrowers, and some borrowers could face similar pressure while they wait to access various assistance schemes and property insurance. However, we do not expect our ratings on most Australian RMBS to be affected by the recent floods, given the strong geographic diversification in most RMBS portfolios. Furthermore, the credit support buffers available in most transactions should be adequate to absorb an increase in the loss severity for affected loans in flood-affected areas. We took no rating actions on RMBS when arrears rose in areas affected by previous natural disasters, such as the Black Saturday fires in 2009, floods in 2011, and bushfires in 2019.
Related Research
ESG in ratings industry-related commentaries:
- The ESG Pulse: Texas Storm Highlights Need For Preparedness, March 23, 2021
- The ESG Pulse: 2020 Lookback, Feb. 15, 2021
- The ESG Pulse: 2021 Lookahead, Feb. 11, 2021
- The ESG Pulse: Reimagining Accounting To Measure Climate Change Risks, Dec. 22, 2020
- The ESG Pulse: COVID-19 Vaccine Hope As Second Wave Sets In, Nov. 19, 2020
- The ESG Pulse: Better Climate Data Could Provide Foundation For Understanding Physical Risks, Oct. 8, 2020
- The ESG Pulse: The Search For A Vaccine, Aug. 31, 2020
- The ESG Pulse: Social Factors Could Drive More Rating Actions As Health And Inequality Remain In Focus, July 16, 2020
ESG industry report cards
- To access our ESG industry report cards click here.
Cross-practice: Sustainable Finance
- Natural Capital And Biodiversity: Reinforcing Nature As An Asset, April 12, 2021
- Six Key Corporate Governance Trends For 2021, March 22, 2021
- Rising Shareholder Activism Mostly Harms Credit Quality, March 17, 2021
- Corporate Governance Practices In The GCC, March 15, 2021
- Transition Finance: Finding A Path To Carbon Neutrality Via The Capital Markets, March 9, 2021
- Sustainability In 2021: A Bird's-Eye View Of The Top Five ESG Topics, Jan. 28, 2021
- Stakeholder Capitalism: Aligning Value Creation With Protection Of Values, Jan. 19, 2021
Sovereigns and supranationals:
- ESG Overview: Global Sovereigns, Feb. 3, 2021
- How Multilateral Lending Institutions Are Responding To The COVID-19 Pandemic, June 9, 2020
International public finance:
- Institutional Framework Assessment: Australian States And Territories, Nov. 9, 2020
- ESG Industry Report Card For Non-U.S. Public And Nonprofit Social Housing Providers, Aug. 4, 2020
U.S. public finance:
- Winter Storm In Texas Will Continue To Be Felt In Utilities' Credit Profiles, March 15, 2021
- 2021 Sustainable Finance Outlook: Large Growth In Green, Social, Sustainable Labels As Municipal Market Embraces ESG, Feb. 16, 2021
- Better Data Can Highlight Climate Exposure: Focus On U.S. Public Finance, Aug. 24, 2020
- California Public Power Utilities Face Disparate Physical And Credit Exposures To Wildfires, Aug. 4, 2020
Corporates and infrastructure:
- China's Climate Ambition Restrained By Supply Security, April 20, 2021
- Asia-Pacific's Energy Transition Will Be Long-Drawn-Out, April 20, 2021
- Winter Storm In Texas Will Continue To Be Felt In Utilities' Credit Profiles, March 15, 2021
- Corporate Governance Practices In The GCC, March 15, 2021
- EU Could Meet 70% Vaccination Target By Late July If Production Steps Up, Feb. 11, 2021
- The Health Care Credit Beat: U.S. Herd Immunity By Midyear Is Possible With Additional Vaccine Approvals, Feb. 11, 2021
- How Russian Companies Are Responding to Growing ESG Pressures, Feb. 8, 2021
- ESG-Driven Industry Risk Assessments Update For Corporate And Infrastructure Ratings, Jan. 27, 2021
- How COVID-19 And ESG Factors Are Weighing On Airports' Credit Quality, Dec. 10
- As COVID-19 Cases Increase, Global Air Traffic Recovery Slows, Nov. 12, 2020
Banks:
- The Greening Of Financial Services: Challenges For Bank And Insurance Green And Sustainability Hybrids, Aug. 12, 2020
- Islamic Finance And ESG: Sharia-Compliant Instruments Can Put The S In ESG, May 27, 2020
- Climate Change: Can Banks Weather The Effects?, Sept. 9, 2019
Insurance:
- COVID-19 Highlights Global Insurance Protection Gap On Climate Change, Sept. 28, 2020
- COVID-19 Pushes Global Reinsurers Farther Out On Thin Ice; Sector Outlook Revised To Negative, May 18, 2020
- Sink Or Swim: The Importance Of Adaptation Projects Rises With Climate Risks, Dec. 3, 2019
Structured finance:
- ESG Industry Report Card: Auto Asset-Backed Securities, March 31, 2021
- ESG Industry Report Card: Collateralized Loan Obligations, March 31, 2021
- ESG Industry Report Card: Commercial Mortgage-Backed Securities, March 31, 2021
- ESG Industry Report Card: Credit Card Asset-Backed Securities, March 31, 2021
- ESG Industry Report Card: Residential Mortgage-Backed Securities, March 31, 2021
- ESG Industry Report Card: Student Loan Asset-Backed Securities, March 31, 2021
- Credit FAQ: How Will The Recent Floods Affect Australian RMBS? March 31, 2021
- Damage Limitation: Using Enhanced Physical Climate Risk Analytics In The U.S. CMBS Sector, Feb. 19, 2021
- COVID-19 Activity In Global Structured Finance As Of Oct. 16, 2020, Oct. 22, 2020
- Credit Concerns Loom On COVID-19 Resurgence, Oct. 21, 2020
ESG In Ratings Criteria-Related Commentaries
Cross-practice:
- The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis, Sept. 12, 2019
Sovereigns and local and regional governments:
- How Environmental, Social, And Governance Factors Help Shape The Ratings On Governments, Insurers, And Financial Institutions, Oct. 23, 2018
U.S. public finance:
- Through the ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020
- When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason, March 28, 2019
Corporates and infrastructure:
- How ESG Factors Have Begun To Influence Our Project Finance Rating Outcomes, Jan. 27, 2020
- How Management And Governance Risks And Opportunities Factor Into Global Corporate Ratings, Nov. 7, 2018
- How Social Risks And Opportunities Factor Into Global Corporate Ratings, April 11, 2018
- How Environmental And Climate Risks Factor Into Global Corporate Ratings, Oct. 21, 2015
Banks:
- How Environmental, Social, And Governance Factors Help Shape The Ratings On Governments, Insurers, And Financial Institutions, Oct. 23, 2018
Insurance:
- How Environmental, Social, And Governance Factors Help Shape The Ratings On Governments, Insurers, And Financial Institutions, Oct. 23, 2018
Structured finance:
- ESG Credit Factors In Structured Finance, Sept. 19, 2019
This report does not constitute a rating action.
| Primary Credit Analysts: | Matthew S Mitchell, CFA, Paris +33 (0)6 17 23 72 88; matthew.mitchell@spglobal.com |
| Karl Nietvelt, Paris + 33 14 420 6751; karl.nietvelt@spglobal.com | |
| Sarah Limbach, Paris + 33 14 420 6708; Sarah.Limbach@spglobal.com | |
| Nicole Delz Lynch, New York + 1 (212) 438 7846; nicole.lynch@spglobal.com | |
| Sarah Sullivant, Austin + 1 (415) 371 5051; sarah.sullivant@spglobal.com | |
| Nora G Wittstruck, New York + (212) 438-8589; nora.wittstruck@spglobal.com | |
| Secondary Contacts: | Kurt E Forsgren, Boston + 1 (617) 530 8308; kurt.forsgren@spglobal.com |
| Joydeep Mukherji, New York + 1 (212) 438 7351; joydeep.mukherji@spglobal.com | |
| Emmanuel F Volland, Paris + 33 14 420 6696; emmanuel.volland@spglobal.com | |
| Dennis P Sugrue, London + 44 20 7176 7056; dennis.sugrue@spglobal.com | |
| Michael Wilkins, London + 44 20 7176 3528; mike.wilkins@spglobal.com | |
| Research Contributor: | Yogesh Balasubramanian, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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