Economic recovery fuels record pace of credit rating upgrades

·2 min read

The economic re-opening is fueling a credit rating rebound among American companies — and those companies are tapping bond markets to take advantage of it.

U.S. corporations saw harsh downgrades in their credit ratings during the depths of the COVID-19 pandemic, as a drying up in financial markets sparked concern of a wave of bankruptcies and defaults.

A safety net from the Federal Reserve helped prevent those corporate collapses from happening, and a faster-than-expected economic recovery is now boosting company earnings.

BofA Global Research noted that upgrades have been running at a record pace for investment grade corporates, the catch-all credit rating bucket for companies not rated as junk (or "high yield"). 

BofA Global Research noted July 6 that it expects net upgrades to continue. Source: BofA Global Research, Bloomberg
BofA Global Research noted July 6 that it expects net upgrades to continue. Source: BofA Global Research, Bloomberg

Across the three major ratings agencies (Moody’s, S&P, and Fitch), BofA calculated that net upgrades were $114.7 billion in June and a record $127.9 billion in May.

“The recent upgrades leave plenty of room for more,” BofA wrote on July 6.

Moody’s similarly noted that whereas downgrades were the major story in 2020, every month in 2021 has seen more upgrades than downgrades by count.

Moody's noted that corporate rating actions
Moody's noted that corporate rating actions "reveal a thoughtful and measured approach to credit" as upgrades outpace downgrades. Source: Moody's Investors Service

The ratings bump also appears to be benefiting companies straddling the line between investment grade and high yield.

Moody’s recorded the default rate at year-end of 2020 at 6.8%, but projects that number to plummet to 1.7% by the end of December, which is lower than the pre-pandemic default rate of 3.6%.

This week, cloud computing company VMWare (VMW) priced about $6 billion in bonds in connection to its spin-off from computer maker Dell (DELL). VMWare is rated BBB- by S&P and Baa2 by Moody's (investment grade) while Dell is rated BB+ by S&P and Ba1 by Moody's (high yield).

BofA noted that the “transaction is part of a larger trend of our expected acceleration in upgrades from HY [high yield] to IG [investment grade].”

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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