November 2024 Edition
Welcome to Global Credit Insights. Every month, we bring you the top research insights from Morningstar DBRS, the leading provider of credit ratings and thought leadership on corporate and sovereign entities, financial institutions, and project and structured finance transactions.
Rating more than 4,000 issuers and 60,000 securities, Morningstar DBRS is one of the top four credit rating agencies in the world. To learn more, visit dbrs.morningstar.com.
U.S. Election Results and the Impact on U.S. Bank Regulations: Gamechanger?
While the results of the U.S. elections bring the prospects of lower corporate taxes and deregulation, we do not expect bank credit fundamentals to be significantly impacted. Community and small regional banks were the biggest beneficiaries from the regulatory changes made during Trump’s first administration, while the largest U.S. banks marginally benefited from regulatory tailoring.
The M&A landscape for banks may benefit with shorter approval timeframes, which may accelerate consolidation trends.
Banks with capital markets businesses may see renewed interest in deal making from their customers.
The impact of potential tariffs on certain sectors of banks’ loan books or customers’ supply chains remains an unknown. We expect the next administration will raise tariffs but primarily in a targeted way.
Inflation Reduction Act Rejuvenates Renewable Energy Tax Credits, but What Are the Credit Considerations?
The IRA introduced two key components that we expect will make a lasting impact on the tax equity market:
The existing tax credits can only be applied to wind and solar projects, whereas starting in 2025, tax credits can be applied to any energy project that achieves net zero GHG emissions, which currently represents a wide scope including solar, wind, standalone battery storage, hydropower, and geothermal.
The creation of transferability, which allows a project to directly sell its tax incentives without the need for a complicated tax partnership structure. A direct sale of tax credits does not allow the project to fully use all aspects of tax incentives, but it greatly reduces structural complexity and opens the tax equity market to new participants.
Into the Unknown: A Look at the Second Trump Administration’s Future Impact on Canadian Banks
Lower corporate taxes and deregulation—as well as Donald Trump’s strong focus on the reshoring of the U.S. economy—are just some of the potential impacts, in varying degrees, that Trump’s second term as President of the U.S. could have on the big six Canadian banks (the Big Six). Nevertheless, we do not expect the Big Six’s credit fundamentals to be significantly affected.
The M&A landscape for U.S. banks could benefit from the implementation of less onerous regulation and shorter approval time frames. This should be broadly neutral for most of the Big Six.
The impact of potential tariffs on certain sectors of the Big Six’s loan books or customers’ supply chains remains uncertain. We expect the new administration will raise tariffs but primarily in a targeted way.
Quarterly U.S. CRE CLO Report: Q3 2024 New Issuance Hits a Two-Year High While Seasoned Transactions Continue to Show Signs of Stress
New Issuance Volume: In Q3 2024, commercial real estate (CRE) collateralized loan obligation (CLO) transactions experienced a noticeable uptick in issuance at $4.55 billion, up from the issuance volume of $678.4 million in Q2 2024 and marking the highest quarterly issuance over the past two years. Total issuance year to date in 2024 totals $4.55 billion.
Deal Type: There were four managed CRE CLO transactions issued in Q3 2024, and the remaining two transactions were static.
Property Types: Most of the collateral in the Q3 2024 transactions are multifamily properties, at 76.12% of all loans contributed to CRE CLOs, an increase from 51.10% in the prior quarter. The remaining property types comprised of industrial, lodging, office, retail, and mixed use.
Germany: Government Coalition Has Broken Up but Tough Budgetary Choices are Here to Stay
Germany's three-party government coalition broke up on November 6th. While the composition of the new government coalition is likely to change, we are of the view that the yet-to-be-elected government will continue to face tough budgetary choices.
While the size of Germany's public debt and budget deficits is moderate from a cross-country perspective, fiscal space is currently narrow.
A more isolationist US foreign policy would most likely require a marked step-up in defense spending by several European Union countries.
Over the medium-term, fiscal accounts will also increasingly be impacted by the retirement of the large baby boomer age cohort. Transfers to the pension system are the biggest social spending item of the central government and account for around 24% of total spending in the 2024 budget.
The Economic Policy Implications of Republicans’ Big Win
Former President Donald Trump defeated Vice President Kamala Harris on November 5th to win the presidency. We expect three policy areas to shape the outlook under a Republican administration:
Expiring tax cuts will be extended.
Tariffs will go up but probably by less than threatened on the campaign trail. In our view, the next administration will likely increase tariffs but primarily in a targeted way and as a means to extract concessions. The imposition of tariffs will likely provoke reciprocal tariffs by U.S. trading partners.
The economic impact of this policy mix over the next two years looks growth neutral and could be modestly inflationary, although the cumulative impact will be driven by the policy details.
European Automotive and Pharmaceutical Industries Highly Exposed to U.S. Tariffs
The European Union (EU) is highly exposed to U.S. tariffs because it is trade intensive, and the U.S. is the largest destination for EU exports. The bilateral trade and investment relationship between the EU and the U.S. is the largest in the world.
Pharmaceuticals, automotives, and chemical products are the most exposed sectors to any potential U.S. tariffs, as they represent the lion's share of EU exports to the U.S.
Auto vehicle production capacity in the U.S. is not sufficient to cover the entire demand in the country, leaving exports from EU plants vulnerable to trade tensions.
The near-term impact of U.S. tariffs on the European pharmaceutical sector would likely be somewhat different. Because of the critical nature of the pharmaceutical industry and inelastic demand, the effect on sales could be comparatively small.
Liquidity Support Remains a Key Factor in Mitigating Defaults
We believe access to liquidity has become a more relevant contributor to the YTD increase in negative credit rating actions for privately rated borrowers.
Although we have observed an uptick in payment defaults across our middle market portfolio over the past year, we find that the level has been mitigated by close co-operation between sponsors and lenders to find flexible solutions for issuers at risk of breaching their loan covenants.
Our review of issuer vintages confirms that the highest level of vulnerability lays with transactions underwritten during the zero-interest rate era from 2018 to 2021. We expect a higher frequency of payment defaults for these older vintages if interest rates remain elevated for an extended period.
Negative Rating Actions for Middle-Market Borrowers Increase Further in Third Quarter
The pace of negative rating actions across privately rated middle market companies increased during Q3 2024 versus Q3 2023, though positive actions also increased compared with a year ago.
We generally expect downgrades to exceed upgrades in private credit through the cycle as sponsors look to minimize the level of committed capital through higher leverage and periodic common-share dividends.
However, we observe that demand for new private credit ratings continues to expand, with YTD new ratings volume up 66% year over year.
We also continue to observe higher credit quality among new issuers relative to existing issuers.
Approach to Data Set
The figures above are based on data from Morningstar DBRS’s proprietary database (ratings from January 1, 2023 to October 31, 2024). The data set includes public and private ratings in all sectors. Morningstar DBRS tabulated confirmations, upgrades, and downgrades at the issuer level; as such, where there are multiple debt security ratings, Morningstar DBRS only used the issuer rating or its proxy for corporates, sovereigns, and FIG sectors, and only used the trust rating for its proxy for structured finance. Morningstar DBRS did not include under review or trend change rating actions in the tables.
Rating actions were counted by aggregating ratings across company IDs and taking the mode of the rating action. As such, in some cases ratings activity may be overstated. For example, Credit Suisse Group AG and Credit Suisse Group Finance (U.S.), Inc. will have two unique company IDs and will thus yield two different ratings counts in our data despite being from the same company.
Morningstar DBRS aims to remove the impact of overstating rating activity by issuing subsidiaries and affiliates (together, related entities) on the data set in cases where there is a direct relationship to the parent company’s rating. The objective of this adjustment is to eliminate the impact of migrating a series of ratings that ultimately rely on one entity. Please note that this approach is specific for the purpose of this newsletter, and may not be consistent with other rating activity summaries produced by Morningstar DBRS for other purposes (such as the transition study data tabulated for the NRSRO).