This report does not constitute a rating action.
Key Takeaways
- While the proportion of speculative-grade companies we rate 'B-' has declined to about 22% of the portfolio from a peak of 29% in mid-2021, we believe this cohort is now particularly exposed to a slowing economy and potentially weaker consumer and business demand.
- Following our interest rate stress tests, we performed top-line and profitability stress testing on our 'B-'-rated issuers, and we estimate that over 42% of these companies are at risk of a downgrade under a moderate revenue and EBITDA margin stress scenario.
- However, this does not account for company-specific actions--such as cost-cutting, refinancing, or asset sales--that could mitigate the impact, suggesting the actual at-risk rate would likely be lower.
- Among the largest sectors by issuer count, commercial and professional services and consumer services appear to be the most vulnerable under various downside stress scenarios.
What We’re Watching
We are monitoring the mounting vulnerability of 'B-'-rated North American corporate issuers amid rising uncertainty, slowing growth, and what is likely to be an extended transition period as President Trump’s fiscal and economic policies take shape. We expect ratings pressure to build, particularly as nearly half of these issuers continue to post free operating cash flow (FOCF) deficits, and about a third of the companies report EBITDA interest coverage deficits. We began 2025 with expectations for earnings growth across the ‘B-’ cohort, but with the macroeconomic backdrop weakening, we now see a growing risk of downward revisions to our company-level forecasts. To help size our speculative-grade portfolio risk, we conducted a stress test.
Stress Test Methodology
We conducted two bottom-up stress tests of our portfolio to assess where the rating tail could move. First, we reviewed the credit measures of over 300 'B-' issuers to identify those most at risk of a downgrade under various revenue and S&P Global Ratings-adjusted EBITDA margin scenarios.
We defined “at risk” issuers as those that meet any two of the following three criteria:
- S&P Global Ratings-adjusted leverage exceeds 8.5x;
- Reported FOCF to debt deficits are worse than -3%;
- Reported EBITDA interest coverage is below 1.0x. We used the most recent financial results available (third or fourth quarter of 2024) to conduct our analysis.
Under our second stress test, we analyzed rating thresholds for 135 issuers (about a third of the population) to gauge the likelihood of breaching the tightest downside quantitative trigger. Combining both scenarios, we identified the industry groups most vulnerable to rating pressure.
Table 1 summarizes the average percentage of 'B-' issuers at risk of a downgrade under various revenue and S&P Global Ratings-adjusted EBITDA margin scenarios under the two stress tests. Approximately 37% of 'B-' issuers--equivalent to about 8% of our speculative-grade portfolio--are considered at risk under a scenario where revenue and earnings growth do not materialize. Under a “moderate” stress scenario, which assumes a 2% decline in revenue and a 3% compression in S&P Global Ratings-adjusted EBITDA margins (to a median of 15.6% from 16.1%), the proportion of at-risk issuers increases to 42%. In a more severe tail scenario--which we refer to as “sharp decline”--with a 4% revenue decline and a 9% margin compression (down to 14.7%), the at-risk share jumps to 54% -- equivalent to 12% of our portfolio.
These downside scenarios translate to a speculative-grade portfolio exposure of 8%-12% attributable solely to 'B-' issuers. Alternatively, in a "solid growth" scenario where revenue rises 4% and S&P Global Ratings-adjusted EBITDA margins grow by 3%, at-risk issuers fall to 28%, or about 6% of the portfolio.
Table 1
Table 2 summarizes the average percentage of 'B-' issuers at risk by Global Industry Classification Standard (GICS) industry group under various revenue and S&P Global Ratings- adjusted EBITDA margin scenarios. Credit quality dispersion remains wide across the 'B-' cohort--even within the same industry--and groups with smaller issuer representation often produce unexpected tail outcomes. As such, we advise against over-interpreting results when the issuer count rank--a relative ranking based on the number of issuers affected under each stress case--is 11 or higher because this typically reflects fewer than 10 issuers and can lead to outsized swings in the data.
That said, we observed moderate shifts in at-risk issuers in the "solid growth" and "moderate" stress scenarios for some groups such as media and entertainment and consumer discretionary distribution and retail, suggesting the weak current state of some issuers and a potentially long and slow path to credit improvement for many ‘B-’ issuers within these industry groups. Furthermore, our more extreme downside scenarios tend to have the most significant credit impact on industry groups with lower EBITDA margins. In contrast, under the solid growth scenario, software and services sector shows the strongest improvement among our top five industry groups. Conversely, the capital goods sector is the most negatively impacted under the moderate decline scenario.
Table 2
| 'B-' Issuers At-Risk Industry Groups Risk Rank | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| GICS Industry Groups | Issuer Count Rank | Median Revenue | Median Margin | "Solid Growth" Scenerio | Current "At Risk" | "Moderate Decline" Scenerio | "Sharp Decline" Scenerio | |||||||||
| Food, Beverage & Tobacco | 14 | 804 | 14.5% | 43% | 53% | 53% | 53% | |||||||||
| Consumer Durables & Apparel | 9 | 869 | 8.9% | 43% | 43% | 43% | 43% | |||||||||
| Commercial & Professional Services | 4 | 841 | 11.4% | 31% | 42% | 49% | 63% | |||||||||
| Consumer Services | 5 | 760 | 17.0% | 34% | 42% | 47% | 59% | |||||||||
| Automobiles & Components | 11 | 1,116 | 14.4% | 36% | 42% | 42% | 50% | |||||||||
| Materials | 6 | 1,380 | 12.6% | 32% | 40% | 44% | 54% | |||||||||
| Technology Hardware & Equipment | 14 | 432 | 17.9% | 20% | 40% | 40% | 60% | |||||||||
| Telecommunication Services | 9 | 2,029 | 22.6% | 40% | 40% | 40% | 60% | |||||||||
| Health Care Equipment & Services | 2 | 1,203 | 9.4% | 23% | 38% | 40% | 56% | |||||||||
| Consumer Discretionary Distribution & Retail | 8 | 1,582 | 8.3% | 36% | 36% | 36% | 45% | |||||||||
| Media & Entertainment | 7 | 782 | 29.7% | 31% | 33% | 36% | 47% | |||||||||
| Software & Services | 1 | 602 | 30.3% | 16% | 33% | 40% | 51% | |||||||||
| Capital Goods | 3 | 858 | 12.2% | 21% | 27% | 39% | 52% | |||||||||
| Pharmaceuticals, Biotechnology & Life Sciences | 14 | 815 | 24.6% | 0% | 20% | 20% | 40% | |||||||||
| Transportation | 12 | 1,621 | 6.9% | 19% | 19% | 44% | 69% | |||||||||
| Energy | 13 | 658 | 39.0% | 17% | 17% | 17% | 17% | |||||||||
| Stress Scenarios--Moderate: 2% revenue decline and 3% compression in adjusted EBITDA margins. Sharp Decline: 4% revenue decline and 9% margin compression. Solid Growth: 4% revenue increase and 3% margin expansion. Revenue and Margin Figures--Represent the medians across our broader portfolio of over 300 'B-' issuers. Issuer Count Rank--Reflects a relative ranking based on the number of issuers affected under each stress case. A lower rank indicates a higher issuer count. Typically, a rank of 4 or lower corresponds to more than 30 issuers, while a rank of 11 or higher indicates fewer than 10 issuers. Source: S&P Global Ratings. | ||||||||||||||||
Why It Matters
'B-' issuers account for just under a quarter of many broadly syndicated CLO portfolios, making their performance a key risk, especially given rising 'CCC' basket exposures that reached 6.2% in March 2025. Furthermore, if more issuers are downgraded to the 'CCC' rating category, the risk of distressed exchanges and liability management exercises rises. These transactions often fail to resolve credit issues but usually provide additional liquidity runway. However, we noted that lenders have experienced weaker actual and expected recoveries as companies redefault. Early identification of downgrade risks allows investors to better anticipate credit deterioration and benchmark internal stress tests.
What We Think And Why
We believe ratings pressure among 'B-' issuers will rise because of slowing growth and increasing policy uncertainty, especially given limited rating headroom and persistent free cash flow deficits. While recent refinancing activity and potential rate cuts may offer some relief, many 'B-' issuers were capitalized at peak valuations during a low-rate environment, leaving them more vulnerable. Our analysis indicates that many of these issuers require sustained, multi-year earnings growth to see a meaningful improvement in credit quality. Persistently weak lender credit protections in loan documentation will likely sustain liability management activity, contributing to lower recoveries and elevated credit losses amid rising redefaults. While S&P Global Ratings projects the default rate will decline to 3.5% by December 2025, we speculate it could remain elevated, pushing closer to our pessimistic scenario of mid-single-digit percent under moderate stress.
What Could Change
As the 'B-' portfolio matures, we believe the performance trajectory is largely fixed for many issuers that have fallen short of their original underwriting cases. Still, the outlook for 'B-' issuers remains closely linked to the direction of interest rates and top-line growth. A stronger economic backdrop--paired with sustained interest rate cuts--could relieve pressure on cash flow and coverage metrics. Additionally, increased M&A, private credit takeouts, or industry consolidation could provide strategic exit paths for the most challenged issuers, helping them address outsized debt burdens. Together, these factors could reduce downgrade risk and help stabilize ratings at the lower end of the portfolio.
Related Research
- The U.S. Speculative-Grade Corporate Default Rate Could Fall To 3.5% By December 2025, Feb. 20, 2025
- North American Sector Recoveries: Actual First-Lien Debt Recoveries Trend Down; Large Drops In Some Sectors, Dec. 10, 2024
- Distressed Exchanges Underpin Rise In North American Selective Defaults, Oct. 28, 2024
| Primary Contacts: | Minesh Patel, CFA, New York 1-212-438-6410; minesh.patel@spglobal.com |
| Shannan R Murphy, Boston 1-617-530-8337; shannan.murphy@spglobal.com |
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