Significant credit rating downgrades would be seen across corporates, financial institutions and sovereigns should the recovery from the coronavirus crisis pan out worse than expected, according to Fitch Ratings.
In its analysis of the “downside scenario” for the coronavirus recovery, the credit rating agency said this would see “renewed large-scale lockdowns across major economies” and “double-dip slowdowns that delay any meaningful recovery beyond 2021”.
The downside scenario would also see a sharper contraction for major economies in 2020 in Fitch’s baseline scenario, followed by a “prolonged recovery phase” with a delayed return to pre-crisis levels of economic output.
The baseline scenario that Fitch outlines assumes severe contractions during the two to three month lockdown periods in major economies, followed by “above average” growth next year.
Where its downside coronavirus scenario differs from its baseline coronavirus scenario is in its recovery trajectory, where the baseline anticipates above average growth in 2021.
However, Fitch – one of the big three credit rating agencies – released its downside coronavirus cases scenario to provide a “consistent context for analyzing further downside risks”.
Below is a heatmap assessing the impact of Fitch’s downside scenario on various global corporates across the different sectors, in order to show which are most vulnerable under these circumstances.
It ranges from very limited or mild ratings impact to high impact and negatively affected. Green represents mild or modest impact and very few potential rating changes on sub investment grade notes.
Yellow represents a medium impact, with many outlook changes and rating changes in investment grade and sub investment grade notes. Pink represents heavy outlook and rating watch activity with numerous rating changes, and red anticipates most or all ratings being negatively affected.
Source: Fitch Ratings
As shown in the heat map, Fitch expects commodities and airlines to be the sectors most vulnerable to ratings downgrades during the downside scenario.
It also highlights sectors exposed most to discretionary spending as most vulnerable to a ratings impact during the downside scenario, which includes non-food retail as well as gaming, lodging & leisure.
On the other hand, traditionally defensive sectors like utilities, telecommunications, healthcare, food retail and food, beverage & tobacco would only likely see a mild to modest impact with few potential rating changes and some outlook changes.
Fitch said similar variables would feed through to global infrastructure, with airports and oil & gas among the sectors most vulnerable. But it said power, energy and other transport would be less exposed but would still likely experience a medium impact.
Source: Fitch Ratings
The rating agency also assessed the impact on sovereign debt and sees six out of seven regions having a medium impact in a downside scenario. It outlined Latin America as most vulnerable.
“We expect Latin America to be the most vulnerable owing to the region's high commodity exposure and limited ratings headroom as well as some countries' weak fiscal position and high public debt,” Fitch explained in the report.
North America and supranationals, however, were vulnerable to some outlook changes but “relatively less” than other regions. Western Europe and Asia Pacific were somewhere in between.
Financial institutions across regions, with the majority of assessed sectors in North America, EMEA, APAC and Latin America, are all expected to experience a medium/high to high impact.
Securities firms, investment asset managers, and non-life insurers/reinsurers are expected to have a medium rating impact, but certain non-bank financial institutions (NBFIs) and insurance sectors would be less exposed.
Source: Fitch Ratings
Interestingly, in structured finance, the large majority of transactions are in sectors expected to experience a medium to high or high ratings impact in the downside scenario.
Fitch said downgrades are “most likely” for non-investment-grade notes and for less-seasoned transactions, but some downgrades of 'AAA' structured finance notes and other senior notes would likely be in the most vulnerable sectors.
Structured finance instruments include asset-backed securities, mortgage-backed securities, collateralized debt obligations (CDOs), and synthetic CDOs or credit default swaps, the villains of the 2008 global financial crisis.