May 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.
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Oil and Gas Fundamentals Diverge
Despite elevated interest rates and overall weak global economic growth, crude oil demand has been stronger than expected thus far in 2024. Simultaneously, OPEC+'s prolonged production cuts have partly offset growth elsewhere, resulting in a modest year-to-date (YTD) global liquids shortfall. Looking ahead, we forecast the recent rise in crude price to stimulate non-OPEC+ production growth and for global demand to moderate as expectations for an economic stimulus from rate cuts fade, tending to cap further price gains.
North American and European gas markets are likely to remain soft through mid-year as a result of excessive U.S. and European gas storage inventories. We expect the U.S. supply/demand balance to gradually tighten as low gas prices discourage new production and, simultaneously, incentivize new demand through 2024. However, given the current abundant gas storage, it will require a robust change in market conditions to enter the 2024–25 winter with inventory at an average or below-average level.
U.S. RMBS Frontline Perspectives
Benchmark Treasury yields surged higher this month, prompting the 30-year mortgage rate to hit 7.17%, up 7 bps week over week (WOW) according to the most recent Freddie Mac Primary Mortgage Market Survey data release last week.
The National Association of Realtors' existing home sales fell, 4.3% MOM in March, after gaining in February, with the median home sale price rising to $393,500, +2.5% versus February. Months' supply inched up to 3.2. On the other hand, new home sales rose 8.8% MOM. The median new home sales price gained 6.0% MOM to $430,700.
Single-family housing starts in March dropped 12.4%, while single-family building permits and completions were -5.7% and - 10.5%, respectively, MOM, according to the U.S. Census Bureau/U.S. Department of Housing and Urban Development, remaining at relatively modest levels.
Boeing, Airbus Q1 2024 Earnings: Diverging Fortunes
Boeing is struggling to implement critical and dramatic production process changes under the keen eye of the U.S. aviation regulator, the Federal Aviation Authority (FAA). The manufacturer is dealing with a self-imposed reduced aircraft delivery plan, is burning through material amounts of cash, and is trying to manage deteriorating public perception that is resulting in passengers avoiding flights using Boeing 737 MAX aircraft, all as the company operates under a veil of uncertainty regarding its ability to achieve near-term targets and limit the damage to its credit profile. Boeing's credit profile has been deteriorating, and we expect it to get worse before it possibly gets better. There is great uncertainty surrounding how and when this might occur.
On the other hand, rival Airbus had the luxury of reporting a solid set of quarterly results with little fanfare and a normal set of management challenges in a difficult operating environment. Airbus' credit profile continues to be supported by its ability to increase production in response to steadily growing global demand for commercial aircraft and production processes that have proven to be more resilient than those of its main competitor.
Canada's 2024 Federal Budget
The Government of Canada (rated AAA with a Stable trend) tabled its FY23–24 budget (Budget 2024) on April 16. With elections on the horizon next year, the federal government has chosen to take advantage of an improved economic outlook to move forward with increased spending in priority areas such as housing, healthcare, cost of living support, and defense.
Revenue gains driven by the better economic outlook and new tax measures will be offset by spending increases in priority areas. Budget 2024 maintains adherence to the government's fiscal anchors over the forecast period, as the debt-to-GDP ratio continues to decline over the medium term. Due to the stronger than expected economic conditions, Budget 2024 shows improvement in the debt ratio (relative to the Fall Economic Statement) through most of the projection period.
First Quarter Private Credit Ratings Activity
We continued to observe erosion in credit quality among the weakest issuers, which drove up the portion of issuers rated CCC (high) or lower. At the same time, although downgrades continued to outpace upgrades during the first quarter, we observed that trend changes in the positive direction exceeded those in the negative direction for the first time in more than a year.
Directionally positive actions during the quarter nearly doubled to 19% of total surveillance actions, comparing favorably with a modest increase in directionally negative actions to 30% from 27%. As a result, the proportion of neutral actions declined 12 percentage points to 51%, as dispersion increased across the portfolio.
In the first quarter, downgrades outpaced upgrades by 2.6 times, slightly higher from 2.3 times a year ago. However, this ratio has declined sharply from a recent high of 5.7 times in the fourth quarter of last year, but generally still in range of most of last year.
Emerging Credit Risks in Project Finance Transactions
Project finance transactions, which historically were dominated by power generating projects, have spread rapidly into other fields and asset classes, including energy infrastructure, essential digital infrastructure, and other intangible assets. These emerging fields have propelled project finance as a popular tool for sponsors to secure alternative debt financing solutions.
We have seen an increase in refinancing and/or re-contracting risk in recent years, as partially amortizing debt and shorter contract terms have become more prevalent in project finance transactions. These risks are especially common within the project transactions to finance data centers and other digital infrastructure assets.
In recent years non-utility companies enter into power purchase agreements as the revenue counterparty, or oil and gas upstream companies pay the pipeline project under contract. The credit risk of the revenue counterparties in these types of transactions can be more volatile, which in turn may increase the volatility of a project’s rating. In such cases, the project lenders are exposed to not only the project’s standalone risk but also the higher volatility of the counterparty’s credit quality.