articles Ratings /ratings/en/research/articles/220523-credit-faq-could-increasing-volatility-impact-rating-trends-12383097 content esgSubNav
In This List
COMMENTS

Credit FAQ: Could Increasing Volatility Impact Rating Trends?

COMMENTS

Credit Trends: U.S. Corporate Bond Yields As Of Oct. 2, 2024

COMMENTS

Default, Transition, and Recovery: The U.S. Leveraged Loan Default Rate Is Set To Remain Near 1.5% Through June 2025

COMMENTS

Default, Transition, and Recovery: Monthly Defaulted Debt More Than Doubled To $14.9 Billion In August

COMMENTS

Default, Transition, and Recovery: 2023 Annual Infrastructure Default And Rating Transition Study


Credit FAQ: Could Increasing Volatility Impact Rating Trends?

Financial markets have been increasingly volatile this year, with implications for issuance and credit stability. While S&P Global Ratings does not believe market volatility causes rating changes, we see market volatility as a response to fundamental stressors appearing or building. Below, we address frequently asked questions about market volatility, increased credit financing costs, and related topics.

Frequently Asked Questions

Are rising benchmark yields a clear negative for credit?

Not typically, but persistent inflation could tip the balance in some regions this time. We have seen eye-catching increases in key benchmark yields year-to-date, with 10-year Treasury, Bund, and Gilt yields still all up at least 80 basis points (bps), despite a recent sell off. This trend is more consistent with less liquid credit markets. It is not in itself unexpected that monetary policy is tightening in many regions as economies continue to recover from the pandemic. Nor are rising rates necessarily negative for credit, as they typically follow economic growth, which usually underpins improving credit conditions.

The atypical aspect of the current rise is how inflation--currently at a 40-year high in the U.S and regularly surprising to the upside--is leading to increasing uncertainty around major central banks' reactions. A potential risk for some central banks, most notably the Federal Reserve, is that while their actions may suppress inflation, they may also suppress growth and potentially contribute to a recession, which would be a clear negative for credit. The Fed is increasing the pace of tightening, the Bank of England raised rates in May to the highest in 13 years, the Swedish Riksbank unexpectedly hiked rates in early May, and the Reserve Bank of Australia raised rates sooner than expected. S&P Global's qualitative assessment of recession risk in the U.S. over the next 12 months is 25%-35% with risk greater in 2023 as successive rate hikes take hold. While this indicates only the possibility--not the probability--of a recession, that does not mean credit will be immune, with slower growth impacting revenue and rising yields already increasing nominal financing costs.

Chart 1

image

What is happening with credit financing costs?

Credit financing costs are rising across the board. In first-quarter 2022, the rise was led by nominal yields and is now being driven by widening credit spreads. In the first quarter, corporate yields took their cue from benchmark yields and continued to rise steadily, meaning nominal financing costs also rose. More recently, corporate credit spreads, which have been volatile year to date, have risen sharply--surging past February 2022 peaks when the Russia-Ukraine conflict erupted--and are now at least 20% higher than the start of the year. The possibility of a recession or at least slower growth, amid a backdrop of continuing cost and supply chain pressures, is forcing investors to reevaluate credit risk premia.

For existing debt, higher yields weigh heaviest on floating-rate issuers such as those that issued leveraged loans. In the U.S., over 60% of outstanding speculative-grade debt through 2026 is loan-based. Much of this is from issuers that we rate 'B-' and at a time when LIBOR floors are very low, on average (roughly 43 bps compared to historical averages near 100 bps). This means the current crop of loan issuers are weak from a credit perspective and likely to feel the pinch of higher rates quickly.

Chart 2

image

Chart 3

image

If financing costs are rising, can issuers still access primary markets for new financing?

This depends heavily on the issuer, its location, and the instrument it plans to issue. Global bond issuance volumes are down 19% compared to the same period last year. Regionally, Asia-Pacific is broadly in line with 2021 issuance while U.S. and European issuance is down around 32% and 25%, respectively.

Investment-grade issuance makes up around 90% of global issuance year-to date and issuers can continue to access markets, albeit at higher costs. In contrast, speculative-grade bond primary issuance is down over 70% and has effectively ground to a halt in many regions outside the U.S. In fact, the recent primary market freeze in Europe lasted longer than the one induced by COVID-19, and issuance--particularly speculative-grade bonds and to a lesser extent leveraged loans--continues to be very thin despite a generally positive first quarter for many issuers.

Demand dictates supply in credit markets and the demand side for bonds had an unforgiving start to 2022. Regardless of credit quality, investors have generally had to deal with negative returns, lower liquidity, a current trend toward fund credit outflows, and the Russia-Ukraine conflict. Primary markets for speculative-grade borrowers in particular are likely to remain volatile at best and difficult to access at worst.

Chart 4

image

Given volatile primary markets, will near-term refinancing risk rise?

Global near-term maturities of rated debt appear manageable. Based upon data as of Jan. 1 2022, corporate issuers continued to extend maturity walls and reduce near-term maturities during 2021, lowering the amount of rated global financial and nonfinancial debt maturing through 2024 by 9%.

In the U.S., maturities through 2024 are at least 40% below 10-year average issuance, and 2023 maturities are in line with the lowest amount of debt issuance over the past 15 years (2008). In Europe, maturities through 2024 are about 15% or more below 10-year average issuance,

Near-term speculative-grade debt maturities in the U.S and Europe could be more problematic in a stress scenario. U.S. and European speculative-grade maturities in 2023 are 16% and 41%, respectively, above the lowest amount of speculative-grade debt issuance over the past 15 years (2008/2009), meaning a prolonged period of market volatility could place pressure on forthcoming refinancings.

Chart 5

image

Can S&P Global describe current rating performance trends? What rating sectors are most vulnerable to market volatility?

Positive rating momentum has been slowing. After 42 weeks with upgrades largely exceeding downgrades, downgrades have exceeded upgrades in six of the last 10 weeks--primarily but not exclusively due to the Russia-Ukraine conflict. Positive rating momentum has largely stalled and the overall rating distribution remains materially below where it was before the pandemic (see chart 6).

The level of speculative-grade debt remains near an all-time high. Rated debt levels are currently 6% higher than before the pandemic, leaving lower-rated issuers vulnerable to market shocks (see chart 7). As inflationary pressures and supply chain issues continue to weigh on issuer balance sheets, many may face weaker-than-expected performance--particularly those at the lower end of the rating scale. Total average leverage for both U.S. and European issuers rated 'CCC+' and below is over 10x.

We are seeing growing divergence between regions, as the pace of recovery in Europe appears slower than in the U.S. and Canada. The percentage of 'CCC' rated issuers in Europe, at 11%, is higher than its five-year average of 8%. In the U.S. and Canada, the percentage of 'CCC' rated issuers has fallen to just 8%, below its five-year average of 9%. Furthermore, while defaults in the U.S are at their lowest since 2011, year-to-date defaults in emerging markets are at their highest since 2009.

Chart 6

image

Chart 7

image

How have ratings performed during previous periods of market volatility?

Prior bouts of market volatility, at least in the U.S. and defined using the VIX, have at times led to increased credit deterioration (see chart 8), though this relationship is far from precise. Large downgrade cycles have been preceded by either acute spikes in market stress (when the VIX is above 40) or periods of heightened--if not acute--stress, like from mid-1997 to early 2003, when the VIX often averaged over 25 a month. However, smaller downgrade cycles can occur with loose lag times and sensitivity to increased volatility, such as from mid-2011 to mid-2019.

Given the level of market volatility today, it does seem the current, all-time low downgrade rate will be tested--not least because it is well below any prior minimum. This may be more likely if market volatility increases or remains elevated this year.

While we do not believe market volatility causes rating changes, we see market volatility as a response to fundamental stressors appearing or building, such as declines in corporate profits or a pending recession. In fact, each period of acute market stress has also appeared during or before a recession--the more likely the driver of ratings downgrades and defaults.

Chart 8

image

How would a prolonged period of market volatility affect ratings?

Lower-rated issuers will be the most exposed if access to capital markets becomes restricted. Issuers in the 'CCC'/'C' category would likely be the first to be negatively impacted because they tend to have high leverage and inadequate liquidity, followed by 'B-' issuers. Globally (excluding Russia), 5% of corporate issuers are rated 'CCC'/'C' and 15% are rated 'B- ' or lower. In a period of prolonged market volatility, capital market access for lower-rated speculative-grade issuers could become a problem, with nearly 1 in 6 rated 'B-' or below.

The consumer products and media and entertainment sectors combined account for 44% of corporate issuers rated 'CCC'/'C' with negative outlooks or on CreditWatch negative globally. Strained consumer and advertising budgets are key risks for these sectors. Other sectors to watch include the automotive, capital goods, and retail and restaurants sectors, which could be pressured by persistent inflation and supply-chain issues. These three sectors combined currently account for 16% of corporate issuers rated 'CCC'/'C' with negative outlooks or on CreditWatch negative globally.

Chart 9

image

This report does not constitute a rating action.

Credit Markets Research:Patrick Drury Byrne, Dublin (00353) 1 568 0605;
patrick.drurybyrne@spglobal.com
Nicole Serino, New York + 1 (212) 438 1396;
nicole.serino@spglobal.com
Ratings Performance Analytics:Nick W Kraemer, FRM, New York + 1 (212) 438 1698;
nick.kraemer@spglobal.com
Jon Palmer, CFA, New York 212 438 1989;
jon.palmer@spglobal.com

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 acknowledgement 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 nonpublic 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.spglobal.com/ratings (free of charge), and www.ratingsdirect.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.spglobal.com/usratingsfees.

 

Create a free account to unlock the article.

Gain access to exclusive research, events and more.

Already have an account?    Sign in