Rising Stars Accelerated In April

In April, five issuers became rising stars (issuers upgraded to investment grade from speculative grade)--the highest monthly total since before the COVID-19 pandemic. This continues the trend of improving credit quality that we're seeing for many investment-grade, and near-investment-grade, issuers that we highlighted in our last report, "'BBB' Pulse: After A Turbulent Year, Rising Stars Once Again Outnumber Fallen Angels." Year to date (through April), rising stars outnumber fallen angels (issuers downgraded to speculative grade from investment grade) 14 to seven.

The ratio of rising stars to speculative-grade issuers (rated 'BB+' and lower) has steadily risen since the end of 2020, when it fell to an all-time low of 0.2%. While the ratio climbed to 0.6% at the end of April, it remains far below the trailing-10-year average of 1.1%.

Chart 1

Of the five new rising stars, four were previously potential rising stars (issuers rated 'BB+' with positive outlooks or ratings on CreditWatch with positive implications).

The first three are real estate firms that benefited from strong profitability, increased cash, and decreased debt--PulteGroup Inc., Shimao Group Holdings Ltd., and MDC Holdings Inc. Russian shipping firm Sovcomflot PAO was upgraded because of increased financial flexibility, after paying down debt with its IPO proceeds and diversification of its business lines. The remaining rising star was semiconductor producer Qorvo Inc., which posted strong growth for two quarters and will likely see continued strong demand from 5G smartphone makers.

The Number Of Potential Rising Stars Continues To Increase

Six issuers were added to the list of potential rising stars in April, which was the largest number of additions since the pandemic began and brought the total count to 16. Moreover, four out of the 16 are on CreditWatch positive, which typically has a shorter resolution time than a positive outlook (typically within 90 days for a CreditWatch, compared with up to two years for an outlook, see "Guide To Credit Rating Essentials, What Are They And How Do They Work?").

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Mergers and acquisitions (M&A) continue to lift some issuers' credit quality, particularly when they involve being acquired by a higher-rated entity, or when they involve credit-positive synergies or diversification of businesses. Two of the issuers added to the potential rising stars list in April came after announcing M&A plans. The ratings on Cadence Bancorporation were put on CreditWatch positive after announcing its planned merger with 'BBB' rated BancorpSouth Bank. The rating outlook on New York Community Bancorp was revised to positive after its agreement to acquire Flatstar Bancorp, which could improve revenue diversification, deposit funding, and interest rate risk. Nonetheless, we continue to highlight that M&A activity could be a double-edged sword for credit quality and could be a negative for credit quality in cases where there are looser financial policies.

Two issuers that were fallen angels in 2020 have subsequently become potential rising stars-- Minsur S.A. (downgraded to speculative grade in September 2020) and Zijin Mining Group (downgraded to speculative grade in July 2020). Both are in the metals and mining sector, where higher commodity prices combined with increases in production capacity resulted in positive outlook revisions.

The remaining two additions to the potential rising stars list were petrochemical company Alpek S.A.B. de C.V., which is seeing strong operating and financial performance related to higher prices, and Dell Technologies Inc., whose spinoff of its VMWare subsidiary would result in proceeds that would likely be used for debt repayment.

As Rising Stars Gain Momentum, Fallen Angels Continue To Decrease

There were three new fallen angels in April, and the rating actions on two entities are related. All three issuers were also previously potential fallen angels (issuers rated 'BBB-' with negative outlooks or ratings on CreditWatch with negative implications).

The long-term local and foreign currency sovereign credit ratings on Kingdom of Morocco were lowered to 'BB+' following the country's sharp GDP contraction in 2020 that exacerbated the contingent liability risks from rising state guarantees, and led to a deteriorating budget position. OCP S.A., a government-related phosphate producer in Morocco, was subsequently downgraded because we cap our rating on this issuer at the sovereign rating level since we consider OCP a government-related entity.

G4S PLC was downgraded after being acquired by Allied Universal Topco LLC (which was itself upgraded to 'B' from 'B-' after the transaction).

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With few new fallen angels in April, the ratio of fallen angels to investment-grade issuers declined further, to 1.6%, a full percentage point below its mid-2020 peak. This ratio remains lower than its 10-year average of 1.9%.

Meanwhile, the additional cost of funding for a speculative-grade issuer (above the cost of investment grade) has steadied over the past month after declining sharply the past 12 months. The difference between 'BB+' and 'BBB-' option-adjusted spreads has hovered around 90 basis points (bps) over the past month, and while this is much lower than the 244 bps peak in mid-2020, it is still nearly 10 bps above the 10-year average.

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The Number Of Potential Fallen Angels Continues To Decline

In March, the count of potential fallen angels recorded a net decrease of 11--the largest drop since the pandemic began. In April, we saw further declines, with a net decrease of 10 issuers to 74. These included 11 removals and only one addition. This marked the ninth consecutive month with net decreases in the number of potential fallen angels (see chart 5).

Chart 5

The number of potential fallen angels with ratings on CreditWatch with negative implications remained unchanged at three in April. The majority of potential fallen angels face less immediate downgrade risk, since the estimated timeframe of a potential downgrade is typically within 90 days for a negative CreditWatch, compared with up to two years for a negative outlook on an investment-grade rating (see "Guide To Credit Rating Essentials, What Are They And How Do They Work?").

The single addition to the list of potential fallen angels was Chinese e-commerce company Meituan, whose investments into the new business of community group buying could result in deficits for free operating cash flow and EBITDA for two years.

Of the 11 issuers that were removed from the list of potential fallen angels, seven had rating outlooks that were revised to stable or positive.

• Darden Restaurants Inc. was revised to a positive outlook as the casual dining segment faces better operating conditions because of a faster U.S. economic recovery.
• Aviation Capital Group LLC, Retail Opportunity Investments Corp., and SKYCITY Entertainment Group Ltd. had outlooks revised to stable on the back of better-than-expected performances during the pandemic and beyond.
• The outlooks on Celulosa Arauco y Constitucion S.A. and Inter Pipeline Ltd. were revised to stable. Paper products producer Arauco has been seeing higher pulp prices that would assist in deleveraging. Oil and gas transport firm Inter Pipeline announced an update on its production capacity contracting that was consistent with S&P Global Ratings' assessment of its business risk profile.
• The outlook on the sovereign rating on Romania was revised to stable to recognize fiscal consolidation by the new government.

Three other removals were due to downgrades to speculative grade--G4S PLC, Morocco, and OCP S.A. The remaining removal was Yuexiu Real Estate Investment Trust, which no longer had outstanding rated debt by the end of April.

The sector concentration of potential fallen angels has remained largely the same since March. Financial institutions lead the list with 14 (but the proportion of potential fallen angels as a share of the investment-grade population for financial institutions is low because of the high number of rated entities in that asset class). Media and entertainment, including lodging and leisure, leads nonfinancials with 12. Consumer products and utilities have six each and have overtaken real estate as the nonfinancial sectors with the second-most potential fallen angels.

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Related Research

• Guide To Credit Rating Essentials, What Are They And How Do They Work?
• 'BBB' Pulse: After A Turbulent Year, Rising Stars Once Again Outnumber Fallen Angels, May 6, 2021
• Inter Pipeline Ltd. Outlook Revised To Stable From Negative On Contracting Update; 'BBB-' Rating Affirmed, May 1, 2021
• Retail Opportunity Investments Corp. Outlook Revised To Stable On Resilient Operating Metrics; Ratings Affirmed, May 1, 2021
• New York Community Bancorp Inc. Outlook Revised To Positive, Ratings Affirmed On Flagstar Acquisition Agreement, April 29, 2021
• G4S PLC Downgraded To 'B' Following Acquisition By Allied Universal; Outlook Stable, April 23, 2021
• Qorvo Inc. Upgraded To 'BBB-' On 5G Catalyst, Strengthening Mitigation Of Apple Risk, April 23, 2021
• Alpek Outlook Revised To Positive From Stable, On Stronger Credit Metrics, 'BB+' Ratings Affirmed, April 23, 2021
• Minsur S.A. Outlook Revised To Positive From Stable On Increased Production And Higher Prices; 'BB+' Ratings Affirmed, April 22, 2021
• Celulosa Arauco y Constitucion Outlook Revised To Stable From Negative On Expected Deleveraging Amid Higher Pulp Prices, April 21, 2021
• Darden Restaurants Inc. Outlook Revised To Positive On Expectations For Faster Recovery; Ratings Affirmed, April 20, 2021
• Romania Outlook Revised To Stable From Negative On Decreasing Fiscal Risks; 'BBB-/A-3' Ratings Affirmed, April 17, 2021
• SKYCITY Entertainment Group Outlook Revised To Stable On Solid Earnings Recovery; 'BBB-' Ratings Affirmed, April 16, 2021
• Ratings On Morocco-Based OCP S. A. Lowered To 'BB+' Following Sovereign Downgrade; Outlook Stable, April 16, 2021
• Dell Technologies Inc. 'BB+' Ratings Placed On CreditWatch Positive On Planned Debt Reduction, April 15, 2021
• Aviation Capital Group Outlook Revised To Stable On Better-Than-Expected Credit Metrics; 'BBB-' Rating Affirmed, April 15, 2021
• Cadence Bancorporation 'BB+' Rating Placed On CreditWatch Positive Following Merger Agreement With BancorpSouth, April 14, 2021
• Zijin Mining Outlook Revised To Positive On Strengthening Business Position; 'BB+' Ratings Affirmed, April 13, 2021
• Russian Shipping Company Sovcomflot Upgraded To 'BBB-' On Increased Financial Flexibility; Outlook Stable, April 12, 2021
• MDC Holdings Inc. Upgraded To 'BBB-' From 'BB+', Outlook Stable; Senior Note Rating Raised To 'BBB-' From 'BB+', April 10, 2021
• Shimao Upgraded To 'BBB-' On Stable Profitability And Prudent Financial Management; Outlook Stable, April 8, 2021
• PulteGroup Inc. Upgraded To 'BBB-' From 'BB+' On Lower Debt And Strong Credit Ratios, Outlook Stable; Note Rating Raised, April 6, 2021
• Morocco Ratings Lowered To 'BB+/B' From 'BBB-/A-3' On Fiscal Space Erosion; Outlook Stable, April 3, 2021
• Meituan Outlook Revised To Negative On Investment Execution Risk; 'BBB-' Ratings Affirmed, April 1, 2021