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Looking back on a year of increasingly rapid change, credit quality and ratings performance in 2023 played out largely as we expected—with divergences across sectors and regions that saw downgrades increase 4% year-over-year, while corporate defaults reached their second-highest level since 2009. Looking ahead, we anticipate an uptick in credit stress overall.
What We're Watching
While the post-pandemic period has been marked by new, and in some cases unforeseen risks, credit quality and ratings performance, defaults, and bond issuance played out largely in line with our expectations for 2023.
Rising interest rates and uncertain economic conditions were key credit factors to start the year. And while we saw an upside surprise in more robust economic growth than anticipated, this carried with it higher central bank policy rates than expected at the start of 2023.
Credit quality deteriorated again following 2022's decline, and starting from levels still below pre-pandemic despite a net improvement in 2021. Yet the 4% increase in downgrades compared to 2022 hides a divergence at the rating level: 82% of downgrades were speculative-grade ratings, while investment-grade credit continued to exhibit resilience across sectors. Defaults also increased globally, led by the U.S. This was due in part to a sustained period of the country having the highest proportions of leveraged loans and debt issuers rated 'CCC+' and below.
Despite downgrades far outpacing upgrades, there were still some pockets of positive rating actions trends in 2023. Media and entertainment, particularly lodging and leisure, led upgrades as the sector continued to benefit from strong employment, healthy consumer spending, and post-COVID tailwinds.
Meanwhile, bond issuance was mixed—with nonfinancial corporates' issuance increasing, structured finance's decreasing, and financial services experiencing a very modest increase.
| 2023 outcomes largely in-line with our expectations, with slight uptick in stress anticipated for this year | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 forecasts | 2023 rates | 2024 forecasts* | 2022 speculative-grade negative bias** | 2023 speculative-grade negative bias** | 2023 'B-' and lower negative bias** | |||||||||
| Default rates | ||||||||||||||
| U.S. speculative-grade | 4% | 4.4% | 5% | 19.1% | 21.6% | 41.0% | ||||||||
| Europe speculative-grade | 3.25% | 3.5% | 3.75% | 16.4% | 17.3% | 27.0% | ||||||||
| U.S. LSTA | 2.5% | 2.1% | 3% | - | - | |||||||||
| Bond issuance | ||||||||||||||
| Global nonfinancials | 10% | 12% | 3% | |||||||||||
| Global financial services | 1% | 2.3% | 5% | |||||||||||
| Structured finance | -5% | -7% | -10% | |||||||||||
| Source: Bond issuance forecasts as of October 2022 and 2023 for full-year ahead. *Through Sept. 2024. **As of Dec. 31. | ||||||||||||||
What We Think And Why
Credit headwinds intensified last year due to higher real interest rates, elevated financing costs, uncertain economic activity, persistent inflation, and heightened geopolitical disruption. Divergences in ratings performance emerged across sectors and regions, which we expect to perdure in 2024.
Sectors most dependent on discretionary spending (e.g., consumer goods, media and entertainment) and those most sensitive to high interest rates (e.g., real estate) saw credit quality decline, while some sectors consolidated their post-COVID rebound (e.g., airlines, leisure) and others (e.g., oil & gas) even benefitted in the tumultuous macroeconomic environment. Globally, health care and chemicals led net downgrades (downgrade minus upgrades)—marking the most relative downward credit pressures globally in 2023, while consumer products yielded the greatest total downgrades (excluding defaults). Health care has been facing increased debt burdens, both as a large issuer of floating-rate leveraged loans (which have suffered from rising rates) and through increased strain from labor shortages. Comparatively, chemicals suffered from a greater-than-expected decline in global demand. Positive offsets to negative ratings actions emerged in the energy sector, which was supported by the overall macroeconomic environment and particularly by rising global fuel costs.
The U.S. had the world's highest downgrade ratio (downgrades divided by total rating actions) of 62%—10 percentage points higher than in 2022 and 6% above other regions.
Because the U.S. has more speculative-grade issuers than investment-grade and a higher share of credits at the lower end of the scale, the negative tilt is generally to be expected. Also unsurprising is the origination of the world's downgrades: overall, 41% of all downgrades globally in 2023 were from issuers rated 'B-' and below, compared to 32% in 2019.
We expect downgrades will likely continue for the sectors that suffered the most downward momentum in 2023. Health care, chemicals, retail, and homebuilders and real estate had the highest deterioration in terms of increased negative bias in 2023, as declining consumer spending continues to expose those with the most vulnerable cash flows. By rating category, significant downgrade risk is ahead for issuers rated 'B-' and below, whose negative bias increased eight percentage points in 2023, while the overall increase in speculative-grade and investment-grade negative bias was minimal.
Defaults were elevated in 2023—up by 80% since 2022. Consumer facing sectors made up the bulk of defaults—something we expect to see again in 2024 as these sectors continue to lead with the highest levels of weakest links (issuers with a negative outlook or CreditWatch). We expect the U.S. and European trailing-12-month speculative-grade corporate default rate to reach 5% and 3.75%, respectively, by September 2024, from their current levels of 4.4% and 2.8% as of November 2023.
What Could Change
S&P Global Ratings Economics anticipates slower GDP growth, but no recession, along with falling policy rates this year. That said, markets may be overly optimistic about Federal Reserve interest rate cuts in 2024; we expect about half the cuts priced in by the market: 75 basis points (bps) versus 150 bps. Our economists also anticipate the European Central Bank could lower its key rate about 75 bps in the second half of this year.
Against this backdrop, we expect 2024 to bring additional moderate credit deterioration and defaults for more vulnerable corporate and government issuers. Total issuance should largely remain positive for corporations, particularly in the U.S.
Yet, a lot could derail this base case. Looking ahead, some of the same challenges remain and other risks are emerging—all of which require a new playbook for issuers and investors in the debt markets. This year is set to be fraught with uncertainties in a highly volatile political and geopolitical environment. With a record level of national elections this year, including in the U.S., and enduring war between Russia and Ukraine, escalation risks in the Middle East, all have the potential to create disruptions to global trade or new episodes of market volatility.
Writers: Molly Mintz and Joe Maguire
This report does not constitute a rating action.
| Primary Credit Analysts: | Nicole Serino, New York + 1 (212) 438 1396; nicole.serino@spglobal.com |
| Nick W Kraemer, FRM, New York + 1 (212) 438 1698; nick.kraemer@spglobal.com | |
| Secondary Contact: | Alexandra Dimitrijevic, London + 44 20 7176 3128; alexandra.dimitrijevic@spglobal.com |
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