Oct 7, 2020 - Economy

A "K-shaped recovery" in credit markets

Animated illustration of a credit card machine flashing three dollar bill signs.

Illustration: Aïda Amer/Axios

The K-shaped recovery happening in the broader U.S. economy, where the wealthy are seeing their fortunes rise while the poor see theirs fall, also is happening in credit markets, analysts at S&P Global say.

What it means: The pace of overall credit rating downgrades has slowed from earlier this year, but negative outlooks are at historical highs, and defaults could double within a year.

  • Some sectors — like technology, consumer staples, retail essentials, homebuilders and health care — appear likely to navigate the coronavirus pandemic with little or no effect on their creditworthiness.
  • Others face a "bleaker" future and are not expected to see credit ratings recover until at least 2023 — like the auto, leisure, travel, and aerospace industries.

What they're saying: "Downgrades have come down from their peak, but negative outlooks are at historical highs both for nonfinancial corporates (37%) and banks (30%) globally, pointing to more rating actions ahead."

  • "Since the outbreak of the pandemic, credits at the lower end of the scale (‘B’ and below) have represented over half of the downgrades, while 90% of defaults were from credits in the ‘CCC’ category."
  • "We forecast the speculative-grade corporate default rate to double by June 2021, from the current 6.2%, to 12.5% in the U.S. and from 3.8% to 8.5% in Europe."

Between the lines: A record $4.5 trillion worth of corporate bond issuance has come to market year to date, 29% higher than this time last year, and analysts are urging caution as fears of renewed market volatility pushed many corporates to front-load bond issuance ahead of the U.S. elections.

  • The analysts also noted a return of "aggressive financial policies" such as the use of debt by private equity owners to finance dividend payments for themselves paid for by using entities under their ownership to take on potentially unsustainable debt.

What to watch: There is also worry that U.S. election uncertainty in early November and the failure of the EU and U.K. to reach a Brexit agreement by the end of the month could create volatility and constrain access to financing for vulnerable firms.

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