‘Hidden’ debtors may be signaling trouble in the global economy

While investors look for suggestions about the health of the global economy, a research and analytics unit under S&P Global said a “hidden” segment of debtors is gleam early signs of trouble.

Those borrowers are small companies that are not rated by S&P Global Ratings, according to the intercession’s sister division, S&P Global Market Intelligence. A credit rating is an assessment on a government or company’s ability to repay its in hock.

There are many reasons why borrowers choose not to seek a credit rating, including cost savings, infrequent union issuance and investors’ familiarity with the brand. Well-known companies that have in the past opted against a acclaim rating include Italian luxury fashion house Prada and German sportswear brand Adidas.

Generally, though, many entities without an S&P credit rating are small companies that are likely to be the first victims in an money-making downturn, said Michelle Cheong, director and global product development lead for credit solutions data at S&P Universal Market Intelligence.

That group is “very much a hidden, under the radar” segment, Cheong told CNBC in a phone telephone on Monday. That’s because unrated borrowers are much smaller in size collectively: Their total assets suffer with consistently been less than 10% of their rated peers’ over the last five years.

“The unrated essences are like the canary in the mine. They are the ones that usually start to default first — before you see trouble episode among the rated entities — because they are the weaker link,” she added.

Total assets by rated and unrated entities in FY 2018

Informant: S&P Global Market Intelligence (June 28, 2019)

Cheong identified possible risks among unrated issuers by studying needles such as earnings estimates and revenue growth. She also looked for potential distress signals including public ads that appear “negative,” such as corporate restructuring.

Her analysis, which will be presented on Wednesday at the S&P Global Demand Intelligence Annual Singapore Conference, found the financial conditions facing unrated entities weakening across sectors and provinces. With the global economy now slowing down amid an ongoing trade war between the U.S. and China, further deterioration in profession sentiment could result in a sudden increase in defaults.

One worrying trend, Cheong said, is collapse profit margins among unrated entities. A reason behind that is over-investment in less profitable projects due to the availability of at credit in the last few years, she explained.

Analysts have long warned about the dangers of rising debt fueled by low dispose rates globally. The low-rate environment came about after central banks around the world adopted easier nummary policies to stimulate the economy after the financial crisis.

The International Monetary Fund said in its Global Financial Steadfastness Report in April that low interest rates have resulted in a higher level of risky debt in the economy. That has increased vulnerabilities in the fiscal system, which could worsen effects of an economic downturn, according to the IMF.

The analysis by S&P Global Market Intelligence base unrated entities in China, the U.K. and the technology sector in Asia Pacific are among the most at risk of a sudden spike in come up shorts.

Chinese firms have defaulted at an “unprecedented” level this year, while the possibility of the U.K. leaving the European Confederation without a deal has hurt companies’ prospects, according to the study. At the same time, the technology sector in Asia Pacific has been hit by a slowdown in call for and global trade tensions.

Investors have been looking for signs of trouble — especially after the U.S., the wonderful’s largest economy, marked its longest economic expansion in history.

One recession predictor occurred in March: The yield on the U.S. 10-year Moneys note dipped below that of the three-month paper. The phenomenon, referred to as an inversion in the yield curve, has occurred previous to each economic recession in the past 50 years.

Cheong’s analysis of companies not rated by S&P doesn’t date that far bet on a support, but she said unrated borrowers “at the bottom of the barrel” of the U.S. real estate sector (which are thought to have contributed to the international financial crisis)  started to face problems in repaying their debt in 2005 and 2006.

As she noted, that’s “way before all the newsflash started hitting” about the subprime crisis, she said.

But Cheong said merely watching the unrated segment may not be satisfactorily to spot a definite turn in the economic cycle. She explained that studying other trends such as defaults sum total speculative-grade bonds and the number of credit rating downgrades compared to upgrades could help investors develop a outdo picture of the global economic conditions.