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Weakest Links in the Emerging Markets Region are the Highest Since the 2009 Financial Crisis

As the economic landscape within the emerging markets region evolves, the S&P Global Fixed Income Research group looked at some of the region's rating stress indicators and their recent performance. We monitor potential rating action trends by looking at the gap between the number of issuers poised for downgrades and the number of issuers poised for upgrades. The gap widens when the number of issuers poised for a downgrade increases or the number of issuers poised for an upgrade decreases--both of which are indicators of imminent stress. In the emerging markets region, the gap has steadily increased since the fourth quarter of 2014, and as of Sept. 30, 2016, the gap between potential bond downgrades and potential bond upgrades was 137. The number of issuers poised for downgrades (164) is now almost double the region's 10-year average (86), and the number of issuers poised for upgrades this month (27) is also below the 10-year average (33). In addition, the number of weakest links in the region is 16 issuers, the highest it has been since the financial crisis in April 2009.

Potential downgrades are issuers rated 'AAA' to 'B-' that have either negative rating outlooks or ratings on CreditWatch with negative implications. We define potential upgrades as issuers that are rated 'AA+' to 'B-' with either positive rating outlooks or ratings on CreditWatch with positive implications. Weakest links are issuers rated 'B-' and lower with either negative rating outlooks or ratings on CreditWatch with negative implications.

In looking at average percent bias across the region, all sectors had an average negative bias of 28.0% compared with the average positive bias of 6.5%. The media and entertainment sector leads in positive bias, with eight issuers (25%), followed by the consumer product sector with 33 issuers and a positive bias of 18.2%. Negative and positive bias are the proportions of issuers with negative outlooks/ratings on CreditWatch negative or positive outlooks/ratings on CreditWatch positive.

Comparing the proportion of downgrades and upgrades of one sector to all sectors is a useful method for benchmarking rating change activity over time to differentiate trends from normal ebbs and flows of the credit cycle. Looking at the proportion of downgrades and upgrades over the last 12 months versus the last five years in emerging markets shows that financial institutions had high proportions of both downgrades and upgrades.

Rating actions in financial institutions are typically higher than in all other sectors during all points in the credit cycle, owing in part to the aforementioned link with sovereign creditworthiness, which is particularly volatile because of geopolitical risks and fiscal/monetary policy decisions. Over the past 12 months, the sector has had a higher proportion of downgrades (21.6%) than over the last five years (19.5%). The financial institutions sector has the highest number of potential downgrades (53), and the sovereigns sector has the highest number of potential upgrades (five).

The following are additional highlights from our report:

  • The number of weakest links in the emerging markets region is the highest it has been since the financial crisis in April of 2009, with 16 issuers.
  • The gap between the number of issuers poised for downgrades and the number of issuers poised for upgrades in emerging market is 137.
  • Financial institutions lead in potential downgrades (53), and sovereigns lead in potential upgrades (five). Over the past 12 months, the financial institutions sector also has had a high proportion of downgrades (21.6%) and upgrades (27.2%).
  • China leads potential downgrades with 29 issuers. China's economic rebalancing has been slowly moving ahead, driven by more resilient growth in consumption than in investment and export.
  • On the potential downgrades list, 12 of the 17 sectors show higher downgrade risk than they have historically (see Table 1).