Moody's: Stress in commodity sectors will be a key credit hazard in 2016

The global commodity downturn is exceptionally severe in its depth and breadth and is expected to be a substantial factor driving the number of defaults higher on a global basis in 2016, says Moody's Investors Service.

"Commodity sectors are facing staggering adverse conditions driven by a potent mix of slower-than-expected global demand and excess supply," said Mariarosa Verde, a Moody's Group Credit Officer and lead author of the report.

Collapsing commodity prices have placed a significant strain on credit quality in the oil and gas and metals and mining sectors. These sectors have accounted for a disproportionately large 36% of downgrades and 48% of defaults among all corporates globally so far this year. Moody's anticipates continued credit deterioration and a spike in defaults in these sectors in 2016, according to the report, "Growing Stress in Commodity Sectors is a Credit Hazard for 2016."

Moody's expects this commodity downturn to be both longer lasting and more severe than average. "Many companies were temporarily cushioned by hedging programs and fixed-price contracts in the early stages of the downturn," said Daniel Gates, a Moody's Managing Director. "Others have been sustained by cash balances that are eroding. Diminishing liquidity and restricted access to capital markets are now pushing more firms closer to default."

The global commodities crisis has been the sole driver of the increase in the trailing 12-month speculative grade default rate over the past year to 2.7% from 2.1%. Despite worsening corporate credit conditions, a weakening trend in average credit measures globally has not yet led to a material increase in the number of defaults outside of commodity sectors.

In 2016, Moody's expects the default rate to increase for corporates excluding commodities due to growth in the number of highly leveraged low-rated borrowers and recent reduced investor willingness to provide new funding to higher risk credits.

Moody's also notes that companies in the oil and gas and metals and mining sectors sold nearly $2 trillion in bonds globally in the period since 2010. "The sheer volume of commodity related debt poses challenges because it means that credit losses from commodity investments will be substantial for many investors," says Verde. "Considering the maturing stage of the current credit cycle, mounting losses on commodity company debt seem likely to intensify the capital markets' swing to greater risk aversion."

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