Upgrades reached a new high in 2021. Through the first three quarters of 2021, the number of U.S. corporate upgrades (including financial and nonfinancial issuers) has already set a new full year record (with 326), exceeding the prior full year high of 309 from 2010 (see chart 1). Near 11% of U.S. corporate issuers have been upgraded so far in 2021. However, this year's share of upgrades as a percentage of issuers remains lower than that of 2010, when more than 13% of rated U.S. corporate issuers were upgraded. Although the number of upgrades has reached a new high this year, corporate credit is still at the early stages of its recovery from the sharply negative rating actions of 2020. Furthermore, the pace of improvement could be slowing as companies face supply constraints and rising producer costs, which are contributing to rising inflation concerns.

Chart 1

Ratings still have a long road ahead to recover from the downgrades of 2020. Net upgrades (upgrades minus downgrades) through the first three quarters of 2021 have only made up for 161 of the 746 net downgrades from last year (see chart 2). While upgrades (106) solidly outnumbered downgrades (47) in the third quarter, this marked a decrease in the number of upgrades and net upgrades from the second quarter. A slowing pace of net upgrades could further prolong the time it will take for ratings to return to their pre-pandemic levels. While U.S. economic growth remains resilient, S&P Global Economics has revised downward its forecast of real GDP growth for 2021 to 5.7% (from 6.7% in June).

Chart 2

Negative Bias Points Toward Fewer Downgrades

For U.S. companies, the negative bias (the proportion of issuers with negative outlooks or ratings on CreditWatch with negative implications) continued its rapid plunge in the third quarter, suggesting the pace of downgrades may continue to slow.

Speculative-grade ('BB+' or lower) issuers led the decline in negative bias in the third quarter as the speculative-grade negative bias dropped by five percentage points to 16%. This negative bias is the lowest since August 2015 and is below its long-term average. Meanwhile, the speculative-grade positive bias (the proportion of issuers with positive outlooks or ratings on CreditWatch with positive implications) remained largely unchanged during the quarter at 11%, just slightly below its long-term average (see chart 3).

Chart 3

The investment-grade ('BBB-' or higher) negative bias declined by one percentage point during the third quarter, falling to 14%. And the positive bias rose by one percentage point, reaching 6%--just shy of its long-term average (see chart 4). While the positive bias is now showing steady quarterly growth over the past 12 months, its increase has been substantially less than the decrease in the negative bias.

Chart 4

Negative bias fell for all rating categories in the third quarter, with the exception of the 'A' category issuers, where negative bias increased by one percentage point. The negative bias remains highest for issuers in the lowest rating level. 65% of issuers rated 'CCC+' or lower have a negative bias (see chart 5). 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.

Chart 5

Negative Bias Continues To Fall In Most Sectors

Rising demand for leisure travel and services and the continued increase in commodity prices supported the improved outlook in several related sectors. In the third quarter, the negative bias declined by one percentage point or more in 12 of the 18 U.S. sectors and rose by one percentage point or more in three sectors (see chart 6).

Chart 6

For the metals, mining and steel sector, negative bias declined by 13 percentage points in the third quarter to 15%, after a few coal and consumable fuels issuers had negative outlooks revised to stable, without being downgraded, on improved market conditions. The sector's negative bias has fallen 25 percentage points in 2021.

The negative biases in the transportation sector and the media and entertainment sector each fell 11 percentage points in the third quarter. Several issuers in the airlines industry had negative outlooks revised without being downgraded due to a strong rebound in leisure travel. And rebounding consumer spending on leisure also contributed to multiple outlooks that were revised to stable in the media and entertainment sector. The transportation and media and entertainment sectors' negative biases have fallen 36 and 31 percentage points, respectively, in 2021.

The healthcare sector's negative bias increased two percentage points as multiple acquisitions have been announced in the sector.

The aerospace and defense sector's negative bias increased four percentage points and the insurance sector's negative bias increased two percentage points, each because of issuer-specific developments.

Chart 7

Just Three Sectors Show Above Average Downgrade Potential

One method we use to examine downgrade propensity is comparing the current negative bias with the historical average of the sector. Just three sectors now have a negative bias above the long-term average for the sector, down from five in the second quarter (see charts 8-9).

The aerospace and defense sector's negative bias has fallen 10 percentage points this year but remains high at 35%, well above its long-term average (19%). The commercial aerospace industry was severely impacted by the pandemic, and we don't expect credit metrics to recover until after 2023.

Chart 8

Chart 9

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. There are now eight sectors that show above average upgrade potential, up from seven in the second quarter (see chart 10).

The automotive sector has the highest positive bias, with 22%, well above its long-term average (11%). All these issuers have positive outlooks, and most are either auto parts distributors or auto parts manufacturers.

Chart 10

Downgrades Fall To The Lowest Level Since The 1990s

The number of downgrades fell to 47 in the third quarter, which was the fewest quarterly downgrades since the fourth quarter of 1997. Nonfinancial corporate issuers accounted for all but three of the downgrades (see chart 12). Speculative-grade downgrades fell to 38 (from 40), and investment-grade downgrades fell to nine (from 11). These investment-grade downgrades included four fallen angels (issuers downgraded to speculative grade from investment grade), and fallen angels outnumbered rising stars (issuers upgraded to investment grade from speculative grade) for the first time this year.

Upgrades remained elevated in the third quarter. While the number of upgrades slipped to 106 from 121 in the prior quarter, this was still the second highest quarterly tally of upgrades in the U.S. The number of speculative-grade upgrades fell by 6% to 95, while investment-grade upgrades fell by nearly half to 11 (see chart 13). Just over half of the upgrades (54) in the third quarter were of issuers that had been previously downgraded since the start of 2020. And roughly half of these 'round trippers' were upgraded from ratings of 'B-' or lower.

Chart 11

Chart 12

Chart 13

Table 1

Downgrades Were Less Concentrated Among The Lowest Rating Levels In The Third Quarter

Even with speculative-grade issuers accounting for nearly 87% of the rating actions during the third quarter, rating actions were not as concentrated among the lowest rating levels as in the first half of this year. Nearly 35% of rating actions were of issuers rated 'B-' or lower in the third quarter, down from 42% in the second quarter.

The pace of improvement appears to have slowed in the 'CCC'/'C' category, after this category had led upgrades in each of the first two quarters of the year. Upgrades of 'CCC'/'C' issuers fell to 18, down from 33 in the second quarter. Ten of the upgrades were of 'round trippers,' upgraded to 'B-' in the third quarter of 2021 following a downgrade to 'CCC+' or lower in 2020.

Meanwhile, the number of downgrades for issuers rated 'B+' rose to eight from four. 'B' and 'B+' rated issuers accounted for a higher share of downgrades at 34% in the third quarter, up from 25% in the second.

Chart 14

High Technology Led Third-Quarter Upgrades

The high technology sector led with 14 upgrades in the third quarter, up from 10 in the second quarter. Most upgrades were of speculative-grade issuers, and these included two rising stars. Dell Technologies Inc. was the quarter's largest rising star, and Tech Data Corp. was a 'round tripper'. Tech Data Corp. had been downgraded to speculative grade in 2020, when its acquisition by several investment funds managed by Apollo Global Management Inc. was announced. Tech Data Corp. was subsequently upgraded in September 2021 upon the completion of its acquisition by Synnex Corp.

The chemicals, packaging, and environmental services sector followed, with 13 upgrades in the third quarter. Many of these issuers are benefiting from strong demand with the economic rebound, and this demand is also supporting the recent rise in prices for their products.

Upgrades in the media and entertainment (12) and retail and restaurants (10) sectors, two of the hardest hit sectors by the pandemic, remained high in the third quarter. Most third-quarter upgrades in the media and entertainment sector were of issuers that were downgraded in 2020.

Chart 15

Utilities And Consumer Products Sectors Continue To Lead Downgrades

The utilities sector had the highest number of downgrades in the third quarter with nine, up from seven in the second quarter. These downgrades include four investment-grade issuers and five speculative-grade issuers. The largest issuer downgrade was Entergy Louisiana LLC (Entergy Corp.), an electric and gas utility in Louisiana (downgraded to 'BBB+' from 'A-'). There was one fallen angel, Entergy New Orleans LLC (Entergy Corp.), which was downgraded twice (to 'BB+' from 'BBB' and then to 'BB' from 'BB+').

The consumer products sector had the second highest number of downgrades in the third quarter with seven, up from six in the second quarter. All downgrades were of speculative-grade issuers. The largest issuer downgrade was household products company Energizer Holdings Inc. (downgraded to 'B+' from 'BB-').

Utilities (26), consumer products (21), and media and entertainment (21) lead all sectors with the most downgrades year to date.

Table 2

Table 3

Weakest Links And Defaults Continued To Decline In The Third Quarter

The count of weakest links (issuers rated 'B-' and below with negative outlooks or on CreditWatch negative) fell to 160 in the third quarter, from 191 in the second quarter. Weakest links are the issuers with the greatest risk of default, and the declining number points toward fewer defaults.

The number of defaults in the third quarter fell to five, down from 11 in the second quarter--marking the fewest quarterly defaults since third-quarter 2018.

With credit quality broadly improving across multiple sectors, we expect that the U.S. trailing-12-month speculative-grade corporate default rate will decline to 2.5% by June 2022, down from 3.8% as of June 2021. Several indicators point toward a lower default rate ahead, such as: economic growth is expected to remain robust through 2023, speculative-grade upgrades continue to outpace downgrades, and the negative bias indicates lower downgrade risk.

The share of issuers at the lowest rating level has begun to fall, with 36% of speculative-grade issuers rated 'B-' and below at the end of September, down from 40% at the turn of the year (see "The U.S. Speculative-Grade Corporate Default Rate Could Fall To 2.5% By June 2022," Aug. 20, 2021)

Table 4

Table 5

Related Research

• Global Credit Conditions Q4 2021: Supply Chain Strain, Inflation Pain, Sept. 29, 2021
• Economic Outlook U.S. Q4 2021: The Rocket Is Leveling Off, Sept. 23, 2021
• U.S. Media And Entertainment Industry Check-In, Sept. 1, 2021
• The U.S. Speculative-Grade Corporate Default Rate Could Fall To 2.5% By June 2022, Aug. 20, 2021