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The ESG Pulse: A Spotlight On Structured Finance


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The ESG Pulse: A Spotlight On Structured Finance

Chart 1


Table 1

ESG-Related Rating Actions (January-March 2021)
Sovereigns International public finance U.S. public finance Corporates and infrastructure Structured finance Total
Downgrade 5 6 19 34 62 126
CreditWatch negative 0 0 22 14 10 46
Downward outlook revision 1 1 8 8 0 18
Upgrade/Upward outlook revision 0 0 1 10 0 11
Total ESG-related rating actions* 6 7 50 66 72 201
Of which social§ 6 6 12 38 63 125
Of which governance§ 0 1 15 6 0 22
Of which environmental§ 0 0 32 22 9 63
*Rating actions comprise rating, CreditWatch, and Outlook changes over January-March 2021. Since March 30, 2020, S&P Global Ratings references in its press releases when rating changes have been influenced by ESG factors. §The sum of social, governance and environmental actions exceed total ESG rating actions because some actions were influenced by multiple factors.

S&P Global Ratings proposes additional transparency on ESG factors as drivers of credit ratings

Currently we include qualitative ESG insights in many of our credit rating reports. To supplement this, we intend to introduce alpha-numerical ESG Credit Indicators (see below example) to further help explain the influence of ESG factors on our credit rating analysis. Over time, but not before September 2021, we would begin to publish ESG Credit Indicators for rated entities and, where relevant, at the transaction level.

Importantly, such ESG Credit Indicators will not affect our credit ratings because they do not belong to our credit rating methodologies. Instead, they will reflect our qualitative assessment--determined during a rating review, typically by a rating committee--about whether ESG factors have a neutral, positive, or negative influence on the key components of our credit rating analysis specific to each entity or transaction.

Chart 2


Spotlight on ESG in Structured Finance

Our credit ratings on structured finance transactions incorporate ESG credit factors when they could affect the likelihood of timely payment of interest or ultimate repayment of principal by the legal final maturity date of the securities and may be more material for some tranches than others depending on the rating level, time horizon, and available structural mitigants. This differs from our ESG approach to issuer credit ratings that we assign to corporates and sovereigns.

We have just published ESG industry report cards on various asset classes (see "ESG Industry Report Cards For Structured Finance Published, March 31, 2021) outlining the relative gross sector exposures (average, below average, above average) to ESG credit factors (see table).

Table 2

ESG Exposure In Structured Finance By Sector
Sector Environmental Social Governance
Auto asset-backed securities Above average Average Below average
Credit card asset-backed securities Below average Above average Average
Student loans asset backed securities Below average Average Below average
Residential mortgage-backed securities Average Above average Below average
Commercial mortgage-backed securities Above average Average Average
Collateralized loan obligations Below average Below average Average

We highlight the following areas with above average exposures:

  • Auto ABS: Greenhouse gas emissions, with numerous jurisdictions having announced plans to phase out ICE engines. This could result in lower collateral values over time, affecting recoveries and residual values.
  • CMBS: We view CMBS pools as more concentrated than other highly diversified asset classes in structured finance, and environmental risks can have serious and material effects on the value of commercial real estate.
  • RMBS: Housing is one of the most basic human needs, with regulators increasingly focused on ensuring fair treatment of borrowers, predominately retail ones. Aggressive collection practices or failure to underwrite in accordance with applicable regulations would increase legal and regulatory risks. In our view, social risks would be relatively higher for nonprime borrowers given affordability considerations.
  • Credit card ABS: Regulators in many jurisdictions are increasingly focused on credit products with relatively high borrowing costs, and ensuring that lenders are considering the borrower's affordability in their underwriting and ongoing management of revolving credit lines.
  • In our view, social risks would be relatively higher for subprime borrowers given affordability considerations.

In our published rating rationales, we intend to include a dedicated ESG paragraph comparing the transaction to our ESG sector benchmark (where applicable), while identifying the relative ESG risks and opportunities and any structural mitigants to these risks. Through this narrative we aim to add transparency on how our rating analysis has accounted for specific ESG credit factors.

The biodiversity crisis is a still-nascent ESG consideration but climbing up the agenda

Climate change and biodiversity loss are interlinked, but solutions to reduce gas emissions are unlikely to benefit biodiversity in the same way. Though natural capital and biodiversity is creeping up the agenda, climate change dominates. Maybe this is because of the current absence of direct and material financial ties to nature.

That said, the World Economic Forum estimates that more than half the world's GDP is moderately or highly dependent on nature and its services. Terrestrial biodiversity loss is tied to three consumer staples: palm oil, beef, and soy. These soft commodities are responsible for around 70%-80% of the 10 million hectares of natural habitat that the UN Food and Agriculture Organization estimates is lost to deforestation globally each year.

Professor Sir Partha Dasgupta (University of Cambridge) explains in his recent review that "sustainable economic growth requires a different measure than gross domestic product." He says we should adopt not just a flow (GDP) but also a stock approach to wealth--one that considers the aggregate value of all capital assets--to take our use of natural capital into account.

Chart 3


The article by S&P Global Ratings' Sustainable Finance team, "Environmental, Social, And Governance: Natural Capital And Biodiversity: Reinforcing Nature As An Asset," was published April 12, 2021.

Sectors Overview

Chart 4


Sovereigns And International Public Finance

Chart 5


Chart 6


See here for a list of all rating actions in this sector.

Sovereign rating actions continue to be driven by fiscal and economic fallouts from the pandemic, which we consider a health and safety credit factor.  For example, on March 5, 2021, we lowered the long-term credit ratings on Kenya to 'B' from 'B+', due to a sharp slowdown in GDP growth in 2020 tied to the pandemic and a consequent rise in fiscal deficits. We estimate that the pandemic-related economic fallout drove Kenya's real GDP growth down to 0.2% in 2020 from an average of 5.6% in the previous five years. The economic shock also widened Kenya's fiscal deficits and will weigh on its already weak public finances and external debt metrics.

U.S. Public Finance

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See here for a list of all rating actions in this sector

U.S. public finance ESG-driven rating actions in March primarily reflected ongoing credit deterioration of Texas' public power and electric cooperative not-for-profit utilities following Winter Storm Uri.  U.S. public finance took 35 rating actions in March driven by ESG factors, of which 21 were associated with rating reviews of Texas public power and electric cooperative not-for-profit utilities. Our evaluation of environmental and governance risks exacerbated by the February storm led to additional downgrades. The knock-on credit effects of the storm and the consequent liquidity and financial pressures for these utilities may not be over; many ratings remain on CreditWatch negative (see "Winter Storm in Texas Will Continue To Be Felt In Utilities' Credit Profiles," published March 15, 2021.

Elevated governance risks also contributed to our rating actions on two not-for-profit health care institutions: Kuakini Health System in Hawaii and Tower Health in Pennsylvania.  We lowered our ratings on each institution by two notches, to 'CCC' and 'BB-' respectively. An inability to manage risk and execute strategic initiatives to shore up operational pressures contributed to the downgrades.

Corporates And Infrastructure

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See here for a list of all rating actions in this sector

Since the end of 2020, ESG-related actions have moderated to about 20 actions per month.  Despite some impending relief regarding social distancing and other restrictions as vaccines become more available, recovery rates vary, and we have seen virus spikes in different regions across the globe.

Health and safety factors related to the pandemic still accounted for 70% of actions in March 2021, with most actions in the hospitality and real estate sectors.  For instance, we lowered our ratings on MGM Resorts International, Marriott Vacations Worldwide Corporation, and Host Hotels & Resorts Inc. given the anticipated slow recovery of the travel sector. We also took negative rating actions on several U.S. real estate companies; we downgraded Vornado Realty Trust (to 'BBB-' from 'BBB') and Washington Prime Group Inc. (to 'D' from 'CC' following a missed interest payment) as credit metrics weakened amid uncollected rents, deferrals, and/or abatements resulting from the pandemic. We revised our outlook to negative on SL Green Realty Corp. given the potential for a decline in office space demand as companies rethink their needs. We revised our outlook on Federal Realty Investment Trust to negative in part because of retail tenant distress caused by the pandemic. We downgraded Mexico-based real estate developer and operator GICSA to 'B+' because the pandemic has dented rental income from its malls and office tenants, as well as the sale of its residential project, which ultimately weakened GICSA's liquidity position. We expect GICSA's liquidity position and financial performance to remain vulnerable to lockdowns for most of 2021 given the slow vaccine rollout in Mexico.

U.S. private prison operators are exposed to ongoing social and governance risks as they are often criticized for various human rights issues.  These include confinement practices, prisoner violence, and mistreatment. CoreCivic Inc. and The Geo Group, Inc. incurred ratings downgrades following President Biden's Executive Order to The U.S. Department of Justice (DOJ) to not renew contracts with privately operated criminal detention facilities.

Our three-notch governance-related downgrade of U.K. oil service provider Petrofac to 'B+' shows the risk of long-lasting reputational consequences of bribery events.  This relates to corrupted payments allegedly offered in 2013-2014 by a Petrofac employee. The U.K. Serious Fraud Office's investigation started in May 2017 and is ongoing. The UAE's ADNOC recently suspended Petrofac from bidding for new contracts; Saudi Aramco had already done so in 2019.

Financial Services

Financial services ratings have experienced very few ESG-related impacts over the past 12 months.  Over the past year, the banking and insurance sectors have seen hardly any rating or outlook changes directly attributable to ESG factors. The ESG trends we see as most relevant for financial services companies, and which are growing in momentum, are tackling climate change and the standardization of ESG reporting. As many countries target a green recovery post-COVID-19, banks and insurers have an opportunity to support this with regards to the way they allocate capital through lending, investing, or underwriting. This presents opportunities for growth and returns, but also poses challenges as firms look to manage their exposures to climate risks throughout their value chains. However, because banks and insurers are often dependent on the quality of disclosure from their underlying counterparties (for example, borrowers, policyholders, or investee companies), their ability to reliably assess their own exposures can be affected if there are gaps in the underlying data.

Structured Finance

Chart 11


Chart 12


See here for a list of all rating actions in this sector.

Commercial mortgage-backed securities (CMBS) remains the most affected sector in term of health and safety factors related to COVID-19, with a total of 21 ESG-related rating actions in March.  Amid renewed waves of COVID-19 infections and the spread of new variants, social-distancing restrictions continue to weigh on the revenues and credit profile of properties that back loans in CMBS, such as shopping centers.

Related Research

ESG in ratings industry-related commentaries:
ESG industry report cards
  • To access our ESG industry report cards click here.
Cross-practice: Sustainable Finance
Sovereigns and supranationals:
International public finance:
U.S. public finance:
Corporates and infrastructure:
Structured finance:

ESG In Ratings Criteria-Related Commentaries

Sovereigns and local and regional governments:
U.S. public finance:
Corporates and infrastructure:
Structured finance:

This report does not constitute a rating action.

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Research Contributor:Yogesh Balasubramanian, CRISIL Global Analytical Center, an S&P affiliate, Mumbai

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