articles Ratings /ratings/en/research/articles/211019-credit-trends-why-ccc-rated-companies-have-risen-and-default-rates-have-not-12147955 content esgSubNav
In This List
COMMENTS

Credit Trends: Why 'CCC' Rated Companies Have Risen And Default Rates Have Not

COMMENTS

Credit Trends: Risky Credits: Risks Increase For North American 'CCC' And Below Issuers

COMMENTS

Default, Transition, and Recovery: Global Corporate Default Tally Remains At 67 As Defaults Continue To Slow

COMMENTS

Credit Trends: U.S. Corporate Bond Yields As Of Dec. 1, 2021

COMMENTS

Credit Trends: Potential Downgrades Fall While Potential Upgrades Stall


Credit Trends: Why 'CCC' Rated Companies Have Risen And Default Rates Have Not

Low default rates persist despite record levels of 'CCC' ratings.   The initial credit shock of the COVID-19 pandemic on the most vulnerable issuers was severe and fast, as the proportion of issuers rated 'CCC' and below ballooned to record highs. Most of the issuers downgraded at the beginning of the pandemic were seriously affected by health measures and social distancing protocols as both governments and societies responded to the global crisis. Despite the number of 'CCC' issuers spiking to record levels, speculative-grade default rates have not, peaking at half their levels seen in the 2008 financial crisis and then dropping rapidly.

Historically, there has been a strong correlation with the percentage of 'CCC' ratings and default rates.   Typically, more than a quarter of companies rated 'CCC' default within 12 months, spending on average 10 months in the rating category before defaulting. However, only 16% of companies rated 'CCC' as of July 2020 defaulted in the subsequent 12 months. This divergence between the percentage of 'CCC' ratings and default rates that occurred in the middle of 2020 is likely due to the abundance of government and central bank support, capital markets' fast rebound, and largely supportive owners--all providing a lifeline to corporate issuers. The low interest rate environment and appetite for yield has fueled speculative-grade issuance, which reached $508 billion in August as issuers at even the lowest rating categories have been able to borrow cheaply (see chart 3). Strong by historical standards, upgrades have largely outpaced downgrades in the 'CCC' space, and absent any external shocks to the market, we can expect to see the upward trend continue in the near term, temporarily weakening the relationship between the share of 'CCC' companies and the corporate default rate.

Chart 1

image

Chart 2

image

Chart 3

image

Many business models will remain viable once the pandemic ends, and this should support rating normalization.   A large share of the downgrades to the 'CCC' category stemmed from our view of unsustainable balance sheets and deteriorated financial metrics. While it is in many cases too early to tell the long-term implications for some sectors of the economy, our assessments of the business risk profile (BRP) for these companies have largely remained unchanged globally so far, which could suggest a relatively rapid normalization of activity as restrictions fade away.

The profile of a typical 'CCC' rated company has changed in the past 18 months, reflecting the dramatic economic impact of COVID-19.   Before the pandemic, more than half of the companies within the 'CCC' category had a vulnerable BRP. Such companies are very small with a weak market position and intense competition, and they operate in secularly declining industries, such as print-based advertisers, certain brick-and-mortar retailers, etc. This number fell to 30% as of the end of the second quarter of 2021, as relatively stronger companies entered the category due to the material impact of the pandemic on their operations. This phenomenon is even more visible in the hardest-hit industries (leisure, transportation, retail, aerospace, oil and gas, and consumer services), which represent over 55% of the total number of 'CCC' rated companies and for which the share of these with a vulnerable BRP has halved since the pandemic.

Chart 4a

image

Chart 4b

image

Chart 5

image

The pandemic's impact was largely business risk agnostic, but the recovery is not.   Because the 'CCC' rated companies now on average have stronger BRPs, this translates into unusually strong growth (see chart 7) and deleveraging (see chart 8 and 9) prospects, which should eventually support a positive transition out of the category. Although it is uncommon for 'CCC' rated companies to have strong deleveraging prospects, it reflects the uncertainty around our base case when it relies upon favorable business, financial, and economic conditions (end of travel restrictions, normalization of consumption habits).

Even so, the signs of stabilization--and, in time, recovery--from the 2020 downgrade wave are noticeable. Several companies were upgraded out of the 'CCC' category only a short time after being downgraded due to the pandemic. We distinguished three profiles of companies that have rapidly emerged out of 'CCC':

  • Companies with relatively short maturities as COVID-19 hit, which were originally downgraded on refinancing risk before being upgraded as they successfully refinanced (see EnQuest, Tullow Oil, Kirk Beauty, McGraw-Hill Education, Urban One, Kenan Advantage Group). Other upgrades have been transaction-led, due to IPOs or mergers and acquisitions (M&A; see Petco Holdings, Endeavor Operating Co.).
  • Companies that took steps to restructure their balance sheet in 2020, which triggered a default rating under S&P Global Ratings' criteria, were re-rated in the 'CCC' category, only to be upgraded later on as recovery prospects improved (see Rite Aid, Community Health Systems, SM Energy, Callon Petroleum).
  • Companies with business fundamentals less severely affected than expected and benefitting from a rapid rebound (see Cengage Learning, Kronos Acquisition Holdings, LTI Holdings, Diamond (BC) B.V., GC EOS Buyer).

Chart 6

image

The pace of upgrades is likely to be driven increasingly by operating trends rather than financing conditions.   As the first two profiles of companies mentioned above are opportunity-driven and were allowed by the supportive financing conditions, we can expect the number of upgrades to gradually decline in the coming months as business performance becomes the main driver of rating actions. However, as shown in chart 10, it is customary for upgrades out of the 'CCC' category to take longer in the years following a major crisis (such as in 2001-2002 and 2010-2013) as uncertainties take time to dissipate, credit metrics improve, and the improvement is seen as sustainable.

Chart 7

image

Chart 8

image

Chart 9

image

Chart 10

image

Chart 11

image

What's Next For 'CCC' Ratings And Default Rates?

Risk remains abnormally high despite the recent positive rating trend.   Within the leveraged finance sector, a crucial observation remains: leverage levels remain elevated for companies rated in the 'B' and 'CCC' categories, though the divergence between sectors and issuers arising from the pandemic persists. Financial market buoyancy and investor appetite for yield have supported issuers that benefited during the pandemic by pursuing debt-funded M&A or distributing dividends to their owners. By doing so, they passed on any uncertainty regarding their growth and profitability path firmly back in the hands of the lenders.

The divergence between 'CCC' rated entities as a percentage of all speculative-grade ratings and the default rate should fade away as government supports are withdrawn and financing conditions normalize.   Consequently, the convergence of the two figures could occur either if default rates caught up with the still-high share of 'CCC' ratings, or the other way around. The most likely scenario is somewhere in the middle. We expect that the combination of strong recovery prospects for 'CCC' rated companies and less supportive governments and financing conditions would lead the strongest companies to be upgraded and the weakest to default. While we don't expect it in the coming months, default rates could pick up temporarily as issuers are upgraded out of the 'CCC' category, until reaching a new equilibrium and reverting to the original behavior of moving hand in hand.

Related Research

This report does not constitute a rating action.

Credit Markets Research:Nicole Serino, New York + 1 (212) 438 1396;
nicole.serino@spglobal.com
Global Research:Gregoire Rycx, Paris +33 1 4075 2573;
gregoire.rycx@spglobal.com
European Leveraged Finance Research:Marta Stojanova, London + 44 20 7176 0476;
marta.stojanova@spglobal.com
Research Contributor:Lyndon Fernandes, CRISIL Global Analytical Center, an S&P affiliate, Mumbai

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.