Jan. 11 2019 — S&P Global Ratings downgraded 596 global corporate and sovereign issuers (accounting for $2.7 trillion in rated debt) and upgraded 452 (accounting for $2.4 trillion in rated debt) in 2018. About 59% of the downgrades and 57% of the upgrades were based in the U.S., which accounts for about 46% of rated issuers globally.
Across most sectors globally, which generally show stable ratings, current median ratings are at the lowest levels observed in the past 20 years. As market conditions deteriorate, lower ratings typically fall more rapidly than higher ratings. Thus, while ratings are stable at present, we anticipate downgrades when the credit cycle turns from its current benign state to a more volatile one, which may very well be underway.
The consumer products sector had the highest tally of downgrades in 2018, at 69, followed by retail and restaurants at 58. Conversely, financial institutions (60), utilities (52), and oil and gas (41) led in upgrades. Financial institutions and utilities, along with the insurance segment, have the highest median ratings, though financial institutions remain comparatively vulnerable (largely due to sovereign rating pressure on ratings for financial institutions).
In addition to rating actions, the movement of capital through funds' bond allocations is an important measurement to understand market demand for credit. By the end of 2018 (as of Nov. 7), the U.S. and U.K. saw increased bond allocations, including for both mutual funds and exchange-traded funds (ETFs), while the majority of other regions saw a decrease from 2010. The U.S. and U.K. saw similar increments of increased bond allocations, at 6% and 5%, respectively, over this period, whereas Japan, Germany, and the euro area saw the largest decreases in bond allocations, at 27%, 17%, and 10%, respectively. In contrast, equity allocations increased in the U.S. (19%), Germany (5%), and Japan (94%), whereas they decreased everywhere else. Bond allocations still exceed equity allocations in mutual funds and ETFs in all regions except emerging markets and Japan. Data are not available for other economies (see chart 2). This remains a concern because asset volatility and potential capital loss will amplify should a turn in the credit cycle materialize, especially in the U.S., which holds the world's largest debt market.
In 2018, the global downgrade ratio (defined as the number of downgrades divided by the number of total rating actions) was 57%, lower than the historical average of 62% (see table 1). Europe showed the most favorable ratio (50%), and emerging markets showed the least favorable (62%).
In Europe, upgrades (102) were just slightly behind downgrades (103) in 2018. The region's upgrade potential as measured by positive bias (the proportion of issuers with positive outlooks or ratings on CreditWatch with positive implications), at 10%, remains comparatively high. Conversely, the region's downgrade potential as measured by negative bias (the proportion of issuers with negative outlooks or ratings on CreditWatch with negative implications), at 14%, is the third lowest across all regions. (The negative biases for other developed economies--Australia, Canada, Japan, and New Zealand--and emerging markets are marginally lower.)
The downgrade ratio in the U.S., with 354 downgrades and 257 upgrades, decreased to 58% in 2018, which is significantly lower than its historical average of 63%. The U.S. negative bias rose to 17%, which is the same as at the beginning of 2018, while the positive bias fell to 7%.
Consumer Products Had The Most Downgrades, While Financials Led Upgrades
Consumer products had the highest tally of downgrades in 2018, at 69. Ratings in the sector remain low, with 72% of issuers rated in the speculative-grade category ('BB+' or lower), which remains especially vulnerable in the event of deteriorating consumer sentiment and other indicators. Retail and restaurants followed with 58 downgrades. About 86% of the issuers in the sector are rated speculative grade, and 20% face potential downgrades.
Financials had the largest tally of upgrades in the year, at 60, as they have for the past three years (see chart 3). Similarly, utilities followed with 52 upgrades in 2018.
Issuers In Italy, The U.K., And Mexico Lead In Downgrade Potential
Downgrade prospects remain very low across all regions. The negative biases for the U.S. and Europe increased by one percentage point in the fourth quarter, and emerging markets' negative bias decreased by three percentage points (see chart 4). Negative bias in other developed markets remained unchanged in the fourth quarter.
Volatility in ratings (vis-à-vis upgrades and downgrades) typically increases at lower rating categories, while higher ratings are generally more stable. With median ratings in the speculative-grade rating category, the U.S., emerging markets, and Latin America all have higher ratings volatility, while Europe, other developed markets, and Asia have higher median ratings and more ratings stability (see table 2). Over the past five years, declines in creditworthiness have been most pronounced in the U.S., Latin America, and Asia.
Issuers in Italy, the U.K., and Mexico currently show the most downgrade risk, with negative biases of 35%, 22%, and 20%, respectively (see chart 5). Conversely, upgrade potential continues to surpass downgrade potential in Spain, Russia, and Sweden, with positive biases of 20%, 19%, and 9%, respectively. Italian issuers are facing higher downgrade propensity at present, with increased negative bias on the risk of weaker economic growth.
Retail And Consumer Products Continue To Show High Downgrade Potential, While Metals, Mining, And Steel Continues To Show Upgrade Potential
The retail sector has high debt leverage, which, along with the ongoing structural changes in the sector, poses challenges for issuers' creditworthiness. The sector has total debt of roughly $262 billion due over the next five years. It also has the highest negative bias, at 28%, among all sectors (see chart 7). Department stores, specialty apparel retailers, and regional grocery stores are most vulnerable to the sector's risks. The sector's positive bias is markedly low, at 4% (improving from 2% in the previous quarter), signifying limited upgrade prospects. Similarly, the consumer products sector has a negative bias of 23% and positive bias of 4%, indicating heightened downgrade risk.
On the other end, metal prices have been stable, supported by strong demand, lifting upgrade potential for the metals, mining, and steel sector globally. The sector's positive bias is presently at 15%--down from the previous quarter but higher than all other sectors’ ad higher than the historical average of 9%.
The median ratings for the consumer services sector and the high technology sector have fallen by one notch over the past decade (see table 3). The fall in the median rating for consumer services is a result of the recent spate of downgrades in the sector. The number of issuers in consumer services rated in the 'B' rating category and below has increased to 51% from 49%.
High technology currently has negative bias of 9% and positive bias of 7%, though its rating distribution continues to weaken, especially in the 'CCC' and below rating category. The sector now has a median rating of 'B+'. Recently, an influx of new, highly leveraged, low-rated issuers in both the U.S. and Europe has placed downward pressure on the sector's median rating.