In the first quarter of 2021, the U.S. economic recovery strengthened, fueled by an accelerating rollout of COVID-19 vaccinations, a faster reopening schedule within states, and the recently approved $1.9 trillion fiscal stimulus, coupled with December's $900 billion package. With these factors supporting the economic recovery, S&P Global Ratings expects U.S. GDP growth to reach 11.3% annualized in the second quarter, and projects 6.5% growth for 2021. Although we expect it will take several years for many U.S. corporate sectors to recover to their pre-COVID-19 credit metrics, a growing economy and financing conditions have already begun to contribute to a meaningful increase in upgrades, particularly for the lowest-rated issuers.

Additionally, the speculative-grade negative bias (the proportion of ratings with negative outlooks or on CreditWatch negative) has fallen closer to its long-term average, suggesting further future declines in the pace of downgrades. As a result, we lowered our 2021 speculative-grade default forecast to 5.5%, down 1.5 percentage points from our February forecast.

Net rating actions turned positive in the first quarter, with upgrades (99) outnumbering downgrades (66). The majority of upgrades were issuers rated 'B-' and lower. Many were the result of recent refinancing to improve liquidity, extend maturity, and/or lower financing costs as lower-rated companies issue new debt given the current favorable financing conditions. This was the first time since the fourth quarter of 2014 that quarterly upgrades outnumbered downgrades. While the number of upgrades has been increasing monthly since December, downgrades held relatively steady between 20 and 24 per month. (see chart 1). Despite the increase in the number of upgrades, the amount of debt affected by downgrades continued to exceed upgraded debt in the first quarter.

Chart 1

Even though upgrades have begun to outnumber downgrades, the current ratings mix among U.S. speculative-grade companies continues to show weakness, as the proportion of speculative-grade issuers rated 'B-' or lower remains near the all-time high (see chart 2).

Chart 2

Negative Bias Falls Nine Percentage Points

For U.S. companies, downgrade potential (as measured by negative bias, or the proportion of issuers with negative outlooks or ratings on CreditWatch with negative implications) declined sharply and is approaching its long-term average. The overall negative bias (including both investment-grade and speculative-grade) fell by nine percentage points to 27% at the end of the first quarter and is moving toward its long-term average of 22%.

Speculative-grade issuers had a steeper drop in their negative bias in the first quarter than investment-grade issuers. The speculative-grade negative bias dropped by 10 percentage points to 30% in the first quarter, while the investment-grade ('BBB-' or higher) negative bias declined by 5 percentage points to 20% (see charts 3 and 4).

The negative bias now consists almost entirely of issuers with a negative outlook, as only 1% of investment-grade (and 2% of speculative-grade) issuers have ratings on CreditWatch with negative implications. A negative outlook implies a relatively lower risk of downgrade, over a longer time frame, than a negative CreditWatch.

Chart 3

Chart 4

Downgrade Risk Is Falling For Lowest-Rated Companies

The greatest decline in downgrade risk, in absolute terms, was for issuers with the lowest ratings, as the negative bias is falling from a higher level. The negative bias for issuers rated 'B-' and lower declined by 12 percentage points in the first quarter and is down by 27 percentage points from its peak in June. This marked a steeper fall than the 9% decline for speculative-grade issuers rated 'BB+' to 'B' in the first quarter, and these issuers' negative bias declined by 20 percentage points from its peak (see chart 5).

While the negative bias peaked at 68% for issuers rated 'B-' and lower in 2020, this recent peak was below the levels reached after the Great Recession in 2009 and after the bursting of the technology and telecommunications bubble in 2002. However, as issuers rated 'B-' and lower now account for a much higher proportion of issuers than during those prior periods, the number of issuers rated 'B-' and lower with a negative outlook or CreditWatch reached a new high in 2020. Of the speculative-grade issuers with a negative outlook or CreditWatch, those rated 'B-' or lower continue to slightly outnumber those rated 'B' or above (see chart 6).

Chart 5

Chart 6

Even after this recent decline, the negative bias remains elevated for issuers in the lowest rating levels. 76% of issuers rated 'CCC+' or lower have a negative bias (see chart 7). With their weaker credit metrics, lower-rated entities are not as well positioned to weather a business, financial, or economic shock as higher-rated peers. However, robust financing conditions have contributed to ample liquidity for riskier credits, and the economic recovery is contributing to improving business conditions. Together, these factors have helped reduce downgrade risk for the riskiest credits.

Chart 7

While the negative bias had steep declines in the quarter, the positive bias (the proportion of issuers with positive outlooks or ratings on CreditWatch with positive implications) had a more modest change. The speculative-grade positive bias rose by a percentage point to 8% during the quarter, and the investment-grade positive bias was unchanged at 3%.

The most pronounced increase in upgrade potential has been for issuers rated in the middle-range of speculative grade: 'BB-' to 'B'. The positive bias is highest for issuers at 'BB-', which has a positive bias of 13%, followed by the 'B+' and 'B' ratings, at 10% each. The positive bias for issuers rated at these levels has a steeper increase than lower-rated entities. The positive bias for issuers at these levels increased over the past three months and returned to its highest level since 2011 (see chart 8).

Chart 8

Negative Bias Declines Across All Sectors

As optimism grows for the 2021 economic outlook, the negative bias declined by 1% or more in all 18 U.S. sectors during the first quarter. Negative outlooks on many issuers were revised to stable without downgrades (see chart 9).

Chart 9

The oil and gas sector negative bias fell 23 percentage points, the most among all sectors, as OPEC+ announced supply cuts would continue through April and as S&P Global Ratings revised its price assumptions for West Texas Intermediate (WTI) to up to $55 per barrel for 2021 and 2022. However, the price of WTI is unlikely to rise far above the average break-even price for U.S. shale (near $50) and near-term capital expenditures will likely remain limited, leaving speculative-grade oilfield services and exploration and production companies vulnerable. Despite notable improvement, downgrade potential remains high with the negative bias at 40%, the second highest among all sectors (see chart 10).

The retail/restaurants sector negative bias fell 17 percentage points to 24%, and is no longer above its long-term average (27%). However, credit metrics for issuers in discretionary retail are mixed. While we expect some issuers to recover in 2022, apparel (especially formal apparel) and cosmetics are not expected to recover until 2023.

The media and entertainment sector negative bias fell 11 percentage points, but remains elevated at 42%, the highest among all sectors. After the pandemic worsened secular pressures, some companies will remain at risk to negative rating actions during the recovery. The recovery timeframe for out-of-home entertainment issuers will depend on consumer behavior as the economy reopens, but issuer credit metrics may not recover until 2023. The media and entertainment sector also include the leisure subsector where recovery to pre-COVID-19 credit metrics is not expected until 2023 or later. However, advertising dependent companies see stronger advertising trends as the economy rebounds.

The consumer products sector negative bias fell nine percentage points to 30%, but remained above its long-term average (27%). Like retail and restaurants, the outlook for these issuers has improved, along with expectations for consumer spending. However, credit metrics for sectors that are tied to social activity such as food service, cosmetics and apparel still may not recover to pre-COVID levels until late 2022 or early 2023.

Chart 10

Fewer Sectors Now Show Above-Average Downgrade Potential

One method we use to examine downgrade propensity is to compare the current negative bias with the historical average of the sector. Fourteen sectors now have a negative bias above the long-term average for the sector, down from 15 at year-end 2020. At the end of the fourth quarter, the high technology, insurance, and telecommunications sectors had a negative bias below their long-term averages, along with the retail/restaurant sector in the first quarter (see charts 11 and 12).

The aerospace and defense and oil and gas sectors currently have negative biases that are highest above their historical averages. For aerospace and defense, the sector negative bias fell seven percentage points in the first quarter, but remains high at 38%, 19 percentage points above its long-term average, and the third highest negative bias among all sectors. Commercial aerospace issuers had notable credit deterioration amid the pandemic, and their credit metrics may not recover until 2024. For oil and gas, the sector negative bias remains high at 39%, also 19 percentage points above its long-term average, and the second highest negative bias among all sectors.

Chart 11

Chart 12

We use a similar approach to gauge upgrade potential, comparing the current positive bias (the proportion of issuer credit ratings with positive outlooks or on CreditWatch with positive implications) of a sector with its long-term average. Currently, the automotive, metals, mining, steel, and the retail/restaurant sectors currently show above-average upgrade potential (see chart 13).

The automotive sector has the positive bias that's highest above its historical average, at seven percentage points above its long-term average, and the highest positive bias among all sectors, at 18%. The sector positive bias rose four percentage points in the first quarter as three auto supplier outlooks were revised to positive and one auto supplier was placed on CreditWatch positive. Although U.S. light vehicle sales fell nearly 15% year over year in 2020, sales began to recover in the second half after the sharp decline in the second quarter, and are expected to rise by 10%-15% year over year in 2021. While the sector's outlook is improving, annual light vehicle sales in the U.S. are expected to remain below 2019 levels through 2024, and the global semiconductor shortage will likely cut into production in the first half of 2021. Credit metrics for the automotive sector broadly may not recover until 2023.

Chart 13

Upgrades Outnumber Downgrades In Q1

U.S. corporate upgrades rose by 52% quarter-on-quarter, to 99 in the first quarter, marking a six-year high. Nearly half of the issuers upgraded (47) were among those that had been downgraded in 2020. Even with the recent upgrades, many of these issuers are currently rated lower than at the start of 2020. The amount of time we expect the different sectors to recover to pre-COVID-19 credit metrics varies greatly. While some sectors had increased demand and growth during the pandemic, we expect some of the hardest hit sectors will take until at least 2023 to recover.

The number of downgrades fell by 25% to 66 in the first quarter. Nonfinancial corporate issuers accounted for all but one of the downgrades, and 95 of the 99 upgrades. Financial services accounted for just one of the downgrades and four of the upgrades during the quarter (see chart 14).

Chart 14

By rating grade, speculative-grade downgrades fell by 36% in the quarter, falling to 50, their lowest level since the third quarter of 2013. Investment-grade downgrades rose to 16, from 10 in the fourth quarter, (see chart 15).

The number of speculative-grade upgrades rose by 53% in the quarter, reaching a new quarterly high of 93, while the number of investment-grade upgrades rose by one, with six upgrades, (see chart 16). More than half of the upgrades were issuers rated 'B-' and lower.

Chart 15

Chart 16

55% Of Upgrades Were Issuers Rated 'B-' And Lower

Issuers rated 'B-' and lower accounted for 55% of the upgrades in the first quarter. Many were upgraded following new refinancings or capital raises allowing them to extend their maturity, improve liquidity, or lower financing costs. Most of these upgrades were issuers previously downgraded in 2020. Issuers rated 'CCC+' and lower accounted for the largest number of upgrades. Many of these upgrades reflected better-than-expected financial performance, improved refinancing prospects, or increased liquidity.

In the first quarter, 36% of the downgrades were issuers rated 'B-' and lower and largely included downgrades of issuers in the 'CCC'/'C' category. Meanwhile, the investment grade downgrades included an equal number of downgrades from the 'BBB' and 'A' categories (with seven each), and two downgrades from the 'AA' category. Two of the investment grade downgrades were fallen angels, issuers downgraded to speculative grade from investment grade (see chart 17).

Table 1

Chart 17

Media And Entertainment And Oil And Gas Sectors Lead Upgrades

The media and entertainment sector had the highest number of first-quarter upgrades with 16, up from nine in the fourth quarter of 2020 (see chart 18). All upgrades were speculative-grade issuers, and most of these were issuers previously downgraded in 2020. The largest issuer upgrade was Netflix Inc. (to 'BB+' from 'BB'). Gaming companies accounted for five of the upgrades within the sector, several of which recently refinanced debt, lowering interest expense, and extending maturity profiles.

The oil and gas sector had the second highest number of upgrades with 11, up from two in the fourth quarter of 2020. There was one investment-grade issuer and 10 speculative issuers upgraded, and these speculative-grade upgrades include three rising stars: WPX Energy Inc., Parsley Energy, LLC, and QEP Resources Inc. All three were acquired by investment-grade rated issuers, and ratings on the acquired issuers were subsequently withdrawn.

Chart 18

Media And Entertainment And Utilities Sectors Lead Downgrades

The media and entertainment sector also had the highest number of downgrades in the first quarter with 12, down from 13 in the fourth quarter of 2020. There were 10 speculative-grade issuers and two investment-grade issuers downgraded, with one fallen angel (Host Hotels & Resorts Inc.) in the sector. Most downgrades in the media and entertainment sector were hotels, gaming, and leisure issuers. Like the out-of-home entertainment issuers, credit metrics for these issuers may not recover until 2023.

The utilities sector had the second highest number of downgrades with 10, down from 15 in the fourth quarter of 2020. There were five speculative-grade issuers (mostly midstream companies) and five investment-grade issuers downgraded in the sector. The downgrade of Duke Energy Corp. from 'A-' to 'BBB+' accounted for most of the affected debt.

Even as upgrades outnumbered downgrades in the first quarter, the amount of debt affected by downgrades continued to exceed upgrades. The oil and gas sector had the largest amount of affected debt by downgrades in the first quarter, with nearly $112 billion. Although the sector had just six downgrades it included three large investment-grade issuers: Chevron Corporation, Exxon Mobil Corp., and ConocoPhillips. Together, these three issuers accounted for nearly all affected debt in the sector. All three were downgraded after S&P Global Ratings revised its assessment of oil and gas industry risk (see table 2).

Table 2

Rising Stars Outnumber Fallen Angels In The First Quarter

Fallen angels (issuers downgraded to speculative grade from investment grade) totaled two in the first quarter, equal to the number of fallen angels in the fourth quarter of 2020. In first quarter 2021, fallen angels were outnumbered by rising stars. Rising stars totaled five in the first quarter, and already outnumber the total number of rising stars from full year 2020 (see table 3).

Table 3

Defaults Declined In The First Quarter

The pace of quarterly defaults continued to slow in the first quarter, dropping to 14 in the first quarter of 2021, from 26 in the fourth. The number of weakest links (issuers rated 'B-' or lower with negative outlooks or ratings on CreditWatch negative) fell to 265 during the quarter, from 339 at the end of 2020. Weakest links are the issuers with the greatest risk of default, and the declining number points toward lowering default rates.

The reduction in weakest links contributes to our view that the U.S. trailing-12-month speculative-grade corporate default rate will decline to 5.5% in December 2021, down from 6.4% in February 2021. Recent positive revisions to our U.S. economic projections for 6.5% GDP growth in 2021, the passage of the $1.9 trillion and $900 billion fiscal stimulus bills, and the continued decline in the speculative-grade negative bias further supports this view. However, we expect the lingering impact of the pandemic on certain sectors to potentially lead to a protracted period of elevated defaults; above the long-term average trailing 12-month speculative-grade default rate of 4.2%.

Table 4

Table 5

Related Research

• "U.S. Real-Time Data: Poised To Spring Ahead Amid Widespread Vaccine Rollouts," April 12, 2021
• "U.S. Speculative-Grade Corporate Default Rate Forecast For Year-End 2021 Falls To 5.5%," March 30, 2021
• "Economic Outlook U.S. Q2 2021: Let The Good Times Roll," March 24, 2021
• "S&P Global Ratings Revises Oil And AECO Natural Gas Price Assumptions And Introduces Dutch Title Transfer Facility Assumption," March 8, 2021
• "U.S. Restaurants And Foodservice Distributors Face A Jagged Recovery While Food And Beverage Fare Better," March 1, 2021
• "COVID-19 Heat Map: Some Bright Spots In Recovery Amid Signs Of Stability," Feb. 17, 2021

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.