Credit Markets: Finding the Weakest Links

Jacinto Torres, an associate director of S&P Rating Services, contributed to this report.

Who are the "weakest links" in the global debt market? At Standard & Poor's Ratings Services, we use the term to describe those companies, governments, or other debt-issuing entities rated B- or lower, with either a negative outlook from S&P or with ratings on CreditWatch with negative implications, and therefore most vulnerable to default. S&P updates this list monthly.

Negative outlooks and CreditWatch listings serve as good leading indicators of actual downgrades. The proportion of defaulters from the portfolios of the weakest links in the U.S. going back to 1999 in any one- or three-year period is higher than the proportion of defaulters from the entire pool of speculative-grade (issues rated below BBB-). The one-year default rate for weakest links, on average, was 6.6 times higher than for all issuers with speculative-grade ratings since 1999, and was 11 times higher at the end of 2007, when the U.S. speculative-grade default rate was at a 25-year low.

Global weakest links continue to increase sharply, as eroding credit quality leads to lower ratings and more entities with negative outlook or CreditWatch. As of Oct. 15 global weakest links increased for the eighth consecutive month, to 181 (see the full list), with combined rated debt worth over $388 billion.
Recession Is to Blame

The continued increase in weakest links is not surprising given the volatility in the credit markets and the unfolding recessionary conditions in the U.S. In the 2001 recession the sharp rise in defaults accompanied the rise in weakest links. In 2008, 54 of the 61 publicly rated companies that have defaulted through Oct. 15 were weakest links.

Since our September 2008 report, nine entities were removed from the list and 28 were added, for a net addition of 19 issuers. The final issuer added to the list was Uno Restaurant Holdings, which was upgraded to CCC from D following its decision to pay its Aug. 15 interest payment before the 30-day cure period expired.

Of the 28 additions to this month's list, 17 were from the U.S., seven from emerging markets, three from Europe, and one from Canada. The media and entertainment sector had the biggest increase in weakest links, with seven entities, followed by forest products and building materials with three.

The sector breakout of weakest links has consistently identified the media and entertainment, consumer products, forest products and building materials, and retail/restaurants sectors as most vulnerable to default. The media and entertainment sector showed the highest vulnerability to default, with 40 weakest links, constituting 22% of the total number of weakest links. This is followed by consumer products with 19 weakest links, and forest products and building materials and retail and restaurants sectors with 18 weakest links each. Entities in these sectors are particularly vulnerable to cyclical trends in the macroeconomic environment. Moreover, increased domestic and global competition has pressured these companies to adopt more aggressive financial policies, leading to some of the highest volumes of leveraged activity in the past several years.

Geographically, U.S.-based issuers (including those in tax havens such as Bermuda and the Cayman Islands) are featured disproportionately on the weakest links list, accounting for 77.3%. This preponderance is partially attributed to the higher ratings penetration in the U.S. marketplace (see table 5). By volume, the 140 U.S.-based weakest links account for $346.30 billion of debt, or almost 90% of the total $388.52 billion of debt issued by all weakest links. Much of the dollar amount of the U.S. portion of the debt is attributable to giant automakers Ford Motor (F) and General Motors (GM), both of which are rated B-, with ratings on CreditWatch with negative implications.