A deteriorating trend seen in U.S. corporate debt ratings is flashing an early warning sign for the credit market, according to Citigroup Inc.
When there’s a discrepancy on a company’s grade between two of the major rating agencies, it’s now more likely that the issuer will be cut to the lower one, Daniel Sorid, Citigroup’s head of U.S. investment grade credit strategy, wrote in a note last week. When this kind of trend emerged in the past, it preceded spikes in the premiums on investment-grade credit, he said.
“Times like now, when agencies are tending toward bearish over bullish consensus on disputed credits, have coincided with much wider spreads relative to even currently elevated figures,” Sorid wrote.
Rating firms nowadays disagree on a rating about as often as they agree, according to Citigroup’s analysis. For about 10 to 15 percent of credits, there are at least two notches’ difference, the bank says.
Disagreements are increasingly getting resolved by a cut in the higher rating, with the proportion heading toward 80 percent. That level coincided with average investment-grade spreads gapping out in 2003, 2009, 2013 and 2016, Sorid said. In the 2003 and 2009 episodes, the premium exceeded 250 basis points.
U.S. investment grade is facing its worst year since 2008 in terms of total returns, amid a resurgence in investor concern over debt levels at a host of American blue chips, with General Electric Co.’s woes the most prominent.
Citigroup expects spreads to end the year about 5 to 10 basis points wider than current levels, and sees negative sentiment continuing to weigh in 2019.
“A narrative of vulnerability will pervade the U.S. corporate bond market in 2019 as an array of mighty U.S. nonfinancial companies take their turn in the barrel,” Sorid said.
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