Emerging market corporate credit quality down but not out

• Published Month : Monday, 08 Jun 2020 03:00 pm

The coronavirus pandemic has had a devastating impact on companies around the world, but in poorer emerging economies where balance sheets and credit ratings were already weak, the damage is looking particularly widespread.

Of the almost 1,800 rating cuts or downgrade warnings S&P Global has made since the virus exploded, 420 have been in emerging markets, nearly half of all the EM issuers the ratings agency monitors.

With Latin America now the epicentre of the pandemic the numbers are set to rise further. Defaults, missed payments on coupons or principal, are also likely to jump. Moody’s, another ratings agency, predicts up to 13.7% of EM corporate bonds of sub-investment or junk grade may default, meaning the proportion could narrowly top the 2008 financial crisis.

“There is virtually no country on the planet that isn’t affected by this COVID crisis,” said partner and credit analyst at fund manager GMO, Carl Ross. “Overall credit quality is going to decline.”

Corporate debt in emerging markets has been on a sharp upward trend over the past decade, increasing by $18 trillion to $30 trillion in the run-up to the COVID-19 outbreak, according to the Institute of International Finance.

All that extra borrowing means the drag on company earnings, which are now expected to slump 4% rather than grow 15%, is magnified - and not just in terms of defaults.

April’s downgrade of Mexico’s state oil firm Pemex alone saw nearly $60 billion worth of bonds, representing 6.6% of the EM investment grade (IG) market, lowered to speculative grade.

In total, nearly 8% of EM IG corporate and quasi-sovereign issuers have now been cut to junk this year and 2020 could well surpass the record of 13.6% set in 2015 when Brazil and Russia both suffered sovereign rating downgrades to less than investment grade.

Dropping out of the coveted IG bracket matters because some large conservative money managers will not buy or retain weaker-rated assets, meaning borrowing costs rise.

J.P. Morgan analysts reckon another $25 billion of Mexican corporate debt will follow Pemex into junk if the government loses its IG status. With airlines, tourism and manufacturing all reeling around the world, extrapolating the effect globally runs into hundreds of billions of dollars.

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