Pandemic Extends Seven Lean Years for Corporate Ratings

Corporate ratings were already on a long-running downward trajectory before we entered the coronavirus crisis. It’s likely to continue southward. 

Two simple statistics illustrate the scale, before we got to the pandemic.

• Corporate rating downgrades exceeded upgrades in 78 of the last 100 months, and for the last 28 months in a row. The cumulative number of net monthly downgrades in our public portfolio since the end of 2012 (the peak year for eurozone crisis downgrades) is now just shy of 1,000. This is particularly notable because it occurred during a period of benign GDP growth.
• What’s more, in each year since 2016, the highest proportion of new ratings we have assigned have fallen in our ‘B’ category, defined as ‘highly speculative’ and subject to only ‘a limited margin for safety’. 

And yet actual defaults before the coronavirus crisis had been running at non-recessionary lows. We estimated earlier this year that default volumes had fallen $250 billion below the level our ratings implied.

Does this long-term trend tell us anything about how ratings will change in a pandemic?

Negatively, many issuers burnt off cash cushions in better times, with funds redeployed for share buybacks. But falling ratings have clearly mapped to that change, and so we were more conservatively positioned coming into the crisis. Risk appetites have also fundamentally changed so cash flows will now be focused on a very different set of priorities.

We nonetheless expect the negative trajectory to continue. The first wave of negative rating actions is now slowing, but our ratings point to further downgrades. Some more statistics put this into context.

Negative Outlooks/Watches typically apply to an average of 10%-15% of the portfolio in normal times. That figure more than doubled to more than 22% in just eight weeks – from 1 March to 1 May this year – and rises to almost 30% when ‘CCC’/’C’ issuers are included. Revisits to downgraded names are a distinct likelihood - that doubling of Negative Outlooks was driven by freshly-applied Negative Outlooks or Watches to 88% of the names for which we had already taken negative action. 

Historically, between 50%-60% of Negative Outlooks/Watches on corporates are followed by a negative action within 12 months. That figure is likely to rise in times of general stress. So far only around 10% of the negative actions we have taken since the start of March have been repeat actions on the same name, but it’s clear the number of downgrades will continue to rise.

By how much will depend of the degree of success in reopening economies post-lockdown. This will be our next major research topic, with updates at fitchratings.com/topics/coronavirus.