Global Credit Conditions:
Third Quarter 2020
The K-Shaped Recovery
Macroeconomic and credit trends point to a widening gap in credit risks across regions and industries in the year to come. Downgrades have slowed but negative outlooks are at unprecedented highs for both nonfinancial corporates (37%) and banks (30%) globally. As a result, we forecast the speculative-grade corporate default rate to double by June 2021. Banks can absorb the shock generally, but recovery will be slow and uneven.
Global Credit Conditions
The K-Shaped Recovery
Credit trends are on diverging paths. Macroeconomic and credit trends point to a widening gap in credit risks across regions and industries in the year to come.
Downgrades have slowed but negative outlooks are at unprecedented highs. This is the case for both nonfinancial corporates (37%) and banks (30%) globally, indicating more rating actions ahead. Since the pandemic started, weaker credits (rated ‘B’ and below) have represented over half of the downgrades, while 90% of defaults were from companies rated in the ‘CCC’ category. We forecast the speculative-grade corporate default rate to double by June 2021 to 12.5% in the U.S. from the current 6.2%, and to 8.5% in Europe from 3.8%.
Credit metrics are increasingly diverging between industries. Some sectors have been barely touched by the pandemic, such as tech, consumer staples, homebuilders, and retail essentials. For others, including airlines, hotels, and auto to name a few, the credit damage will go well into 2023. Banks can absorb the shock generally, but recovery will be slow and uneven.
Financing conditions remain supportive. Corporate bond issuance has reached a record $4.5 trillion for the year to date, 29% higher than this time last year. But fears of renewed market volatility have pushed many corporates to frontload bond issuance ahead of the U.S. elections. We also see signs of a return of the aggressive financial policies we often saw before the pandemic, such as the use of debt to finance dividend payments.
Economic recovery will take time. Despite better-than-expected bounces in the U.S, the eurozone, and China, healing the global economy will take time, and some emerging markets will suffer sizeable permanent income losses.
Global risks. Risks to our base case include extended COVID-19 containment measures and transition to post-COVID policies, corporate solvency risk, new highs in government debt, struggling emerging markets, economic nationalism and geopolitical tensions, as well as mounting ESG risks.
Credit Conditions North America
Potholes On The Road To Recovery
Overall: While credit conditions are largely favorable for many borrowers, pockets of risk are rising—particularly for U.S. state and local governments, whose tumbling revenues are adding to budget pressures. Risks around commercial real estate, too, are growing.
Risks: The threat of financial-market volatility has heightened as the U.S. election draws near—especially if the presidency is in dispute, as in 2000. Moreover, if Republicans and Democrats continue to split power in Washington, the chance for another round of sweeping fiscal stimulus may disappear.
Credit: Yields on Treasuries and on private-sector debt have all fallen or remain low. Issuance is robust across the credit spectrum, with even the combined leveraged loan and speculative-grade bond offerings to date exceeding the same period last year.
Credit Conditions Asia-Pacific
Recovery Roads Diverging
Overall: The road to recovery is hardly smooth or even. China continues to be a relative bright spot while many other emerging markets struggle to contain COVID-19. Economic fallout has bottomed but the rebound is showing a big disparity among countries as well as sectors, potentially leading to widening variation in credit trends.
Risks: These include mounting debt with suppressed revenue, disruption from lingering containment measures, spillovers from the U.S.-China strategic confrontation, and uneven access to U.S. dollar funding.
Credit: Negative rating actions have tapered for the region in the past quarter with no defaults by rated issuers. However, the net negative outlook bias worsened to nearly onefifth of ratings. Consequently, the likelihood of downgrades and defaults persists.
Credit Conditions Emerging Markets
Fragile And Uneven Recovery, Virus Resurgence Looms
Overall: Credit conditions in emerging markets (EMs) continue showing a gradual improvement stemming from supportive financing conditions, the gradual economic recovery, and the likelihood that a COVID-19 vaccine will be available soon.
Risks: A key developing risk is the phase out of credit forbearance and fiscal stimulus. As these measures are lifted, some of the pandemic's consequences will surface, which could especially stress banks given a potentially rapid deterioration of asset quality, absent additional measures.
People are learning to live with the virus, as weariness with health and safety restrictions rises. The latter raises questions about a potential resurgence in cases over the coming months. Furthermore, winter is coming in the Northern Hemisphere and COVID-19 will coincide with the influenza season potentially setting a setback in beating the pandemic. In our view, this will further pressure health systems and government budgets. Lockdown renewals or additional social-distancing measures could undermine expected recovery. In our view, the risk of policy missteps remains.
Credit: Negative rating actions have plateaued, but lower rating levels and negative outlooks reflect higher leverage and vulnerability to further shocks. A slower economic recovery or failure to deliver a vaccine within an expected time frame could lead to further downgrades.
Credit Conditions Europe
Ill-Prepared For Winter
Overall: Supported by wide-ranging policy measures, Europe has bounced back well from the COVID-19 lockdown coma in the spring. The question now is how stringent containment measures will need to be to suppress the second wave that is breaking across the Continent as winter approaches – and at what cost.
Risks: Key risks remain a resurgence in the virus as winter approaches without a vaccine, the ongoing threat to solvency for companies with weak credit fundamentals, increasing global trade tensions, extended uncertainty inhibiting consumer demand, as well as increasing doubts about whether a U.K.-EU trade deal can be concluded before year-end.
Credit: The shock of the pandemic on productive capacity is enormous but temporary. If, on the contrary, the fallout on human and economic capital is permanent, private-sector bankruptcies will become more pervasive, impairing asset quality in the banking sector and draining the resources of the state.