In This Crisis Rating Agencies Regain Credibility

Most investors remember the reputational beating credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch Ratings took over their inflated structured finance ratings during the Great Financial Crisis (GFC) of 2008. Some critics said their reputations were forever damaged, and they should be broken up or sued out of business. Fast forward 12 years to the great Coronavirus pandemic, and investors are more reliant than ever on the credit rating agencies to help bond investors navigate the potential minefield of global corporate debt defaults that are coming.

Coronavirus Will Kill Some Industries

Coronavirus is not only killing people it has the potential to kill off entire industries. Fitch recently said, “The coronavirus crisis is crushing global GDP growth,” according to Fitch Ratings in its latest quarterly Global Economic Outlook. We have nearly halved the Fitch baseline global growth forecast for 2020 - to just 1.3% from 2.5% in December 2019.”

The virus is hitting industries such as hotels, leisure, entertainment, and travel, particularly hard. As the world economy comes to a standstill in a government-induced hibernation to help contain the virus, these industries will face severe financial distress that will push default rates to levels not seen for years.

Moody’s says they expect US real GDP to contract by 2% in 2020, indicating a full-on economic recession. Forecasts from Wall Street banks are even more dire with expectations that GDP in the second quarter could contact between 15-30%. Weekly US jobless claims released came in at 3.28 million, an absolute record, and 2x higher than the most pessimistic forecast.

Investors Need Guidance

As the US economic machine grinds to a halt, investors will turn to rating agencies to help decide which industries and companies are likely to come out on the other side. The situation is a long way from 2008 when the CEO’s of these companies were facing Congressional inquiries and regulatory probes into “wrong ratings.” Today investors are looking for help as bonds and bond ETF’s like the iShares iBoxx $ Investment Grade Corporate Bond ETF (AMEX: LQD) and the iShares iBoxx $ High Yield Corporate Bond ETF (AMEX: HYG) fall in value.

High yield funds or those with lower quality companies remain particularly vulnerable and remain incredibly volatile. Estimates are that default rates could spike to 10% from a longer-term average of around 2%. Many names that sit on the edge of investment grade will also fall into high-yield, and funds that are not mandated to hold low-quality debt will be forced to sell. Selling pressure will put more downward price pressure on ETFs like HYG. Investors should proceed with caution.

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Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.org. The observations he makes are his own and are not intended as investment or trading advice.