Boeing has experienced a sharp increase in credit risk during the past two years, due to business challenges stemming from 737 MAX safety concerns and the systemic COVID-19 shock, which hit the travel sector and supporting industries particularly hard.
Moody's Analytics' Expected Default Frequency (EDF™ ) measure provides a market-based assessment of the credit risk of the company. Between January 2019 and May 2020, Boeing's probability of default measure increased by 17 times, attributable to increases in both its business risk and financial risk. The underperformance of its commercial airplanes business following the 737 MAX crashes was exacerbated in March 2021, when the COVID pandemic led to global lockdowns, bringing travel to a standstill, pausing commercial aircraft production, and reducing future orders. As a result, Boeing's asset value dropped sharply, leading to a rapid rise in its EDF measure, which reached a peak of 2.13% in May 2020.
Since then, Boeing's EDF measure has improved by more than 70%, but remains substantially above its pre-737 MAX/pre-pandemic levels. As of July 30, 2021, Boeing's one-year probability of default stood at 0.64%, 21 times its Q3 2018 0.03% EDF level. That EDF level is historically consistent with a Ba2 rated credit. Boeing is currently assigned a Baa2 rating by Moody's Investors Service.
Despite recent challenges, early warning signals have been mixed, and they do not currently flag Boeing as excessively risky compared to industry peers. Boeing's EDF has yet to cross its early warning trigger level, and its asset volatility - despite having increased - remains relatively low, within the 13th percentile of the U.S. Aerospace and Defense Group.
Taking a longer-term view, this report also assesses the potential impact of climate change on Boeing's credit risk. Moody's Analytics Climate-adjusted EDF measure projects the paths Boeing's EDF measure might take under different scenarios designated by the Network for Greening the Financial System (NGFS). In addition to the EDF signals for assessing the current credit risks of the company, Climate-adjusted EDF measures are an extension that allows investors to connect climate impacts on the credit risk of their investments.
Boeing's credit risk: 737 MAX groundings and COVID-19 pandemic impacts
Boeing's business has been affected significantly by both the 737 MAX groundings, which received widespread media attention, and the global impact of COVID-19. When we consider the effects of these events on the company's credit risk, measured by Moody's Analytics EDF metric, we find that the pandemic's implications for global travel and demand for aircraft have had the largest impact. Although Boeing's EDF measure has fallen from its pandemic peak in May 2020, uncertainty regarding the travel industry's recovery- especially since the emergence of the Delta variant - keeps the company's risk elevated.
The level and upward trend in Boeing's EDF measure between January 2019 and January 2021 reflect the dual struggles faced during the past two years. The EDF metric measures the expected probability of default over the next year. Figure 1 shows Boeing's EDF measure path from January 2019 to July 30, 2021. Between March 13, 2019 and February 28, 2020, its EDF measure increased by four times, in response to news surrounding the company's 737 MAX business challenges. The pandemic's effect was even more severe. Between March 3, 2020 and November 2, 2020, Boeing's EDF measure increased by 13 times, reaching a peak of 2.13% on May 15, 2020 - a total increase of 17 times compared to its pre-pandemic level. On an implied ratings basis, a 2.13% EDF translates into a Caa3 rating.1
In the past eight months Boeing has seen a marked drop in its probability of default. Since November 2020, Boeing's EDF value has fallen from 1.73% to 0.64% as of July 31. The downward trend in Boeing's EDF measure from January 2021 to the present reflects an upturn in the company's fortunes mainly due to an increase in its asset value (Figure 2), driven by increasing revenue from defense, space, and security as well as increasing sales of commercial aircraft due to the repeal of 737 MAX grounding orders and travel restriction easements, leading to increased investor confidence.
Greater business and financial risks drove Boeing's EDF measure
It is useful to think of the EDF measures as being driven by two fundamental risk factors: business risk and financial risk. Business risk is measured by the volatility of a company's asset value, while financial risk is measured by leverage. A firm's asset value is composed of much more than the sum of its physical and financial assets, especially for companies whose businesses rely upon assets such as intellectual property. Asset value measures the going concern value of a company, and its volatility is directly related to its riskiness. Leverage in the EDF model is also measured on a market-valued basis, inferred from equity valuations, rather than book (accounting) values.2 Market leverage is the ratio of the company's asset value to its default point.
Figure 2 tracks the two factors driving the changes in Boeing's EDF measure. Looking at Figure 2, Boeing's market leverage gradually increased between January 2019 and 2020, due to a continued rise in its default point (orange line) and decreasing market value of assets (blue line). An increase in the default point is a direct result of an increase in a firm's liabilities (short- and long-term). Boeing's $8 billion USD increase in liabilities in its 2019 fiscal year is almost completely accounted for by customer concessions and other considerations, due to the 737 MAX fatal crash incidents and subsequent groundings. Business risk, measured by asset volatility (green line), also steadily increased between January 2019 and January 2021 before stabilizing. From December 2020 onward, Boeing's financial risk steadily decreased, with rising commercial orders due to lifting of COVID-19 restrictions and the gradual restoration of 737 MAX flights, raising Boeing's market value of assets and offsetting the slight increases in its default point.
Navigating the pandemic's wake, Boeing slightly underperformed, but the gap is closing
We obtain additional insight into a company's credit profile by comparing it with its industry peers. A company performing worse (i.e a riskier EDF measure) than its peer group can present additional risk issues, and a company performing better than its peer group can have additional strengths. We find that the pandemic's effect on Boeing's business led to slight underperformance, in credit risk terms, relative to its industry sector.
Boeing's performance relative to its industry peer group is shown in Figure 4. The graph compares Boeing's one-year EDF measure to the 25th, 50th, and 75th percentile EDF measures for the U.S. Aerospace and Defense Group. Traditionally a low-risk industry, the U.S. Aerospace and Defense Group presents a right-skewed distribution, with EDF measures heavily concentrated toward lower values of one-year EDF (EDF values for the 25th. percentile and 50th percentile are nearly indiscernible prior to the pandemic). However, the COVID-19 pandemic has made the entire industry group increasingly risky, with the median EDF measure rising more than 13 times since the virus affected the global economy, and the 75th percentile of EDF measures widening to approximately 3 times its pre-pandemic level.
In the immediate aftermath of the pandemic's economic impact, Boeing's EDF jumped to four times the industry median. The rise in the company's EDF from around the 25th percentile to just below the 50th percentile between January 2019 and January 2020 is due to the decline in commercial sales and investor confidence from the 737 MAX crashes and subsequent groundings, and the sharp rise in the company's EDF from below the sector median to above the median reflects the particularly severe shock Boeing received from COVID-19. However, we should put the relative increase in Boeing's credit risk in perspective. Despite the increase, Boeing's probability of default is not excessively high compared to its sector. Moody's Analytics research has shown that only when an EDF measure rises beyond the 75th percentile (or more, depending on the sector), does such a move signal excessive credit risk. Boeing's EDF has been and remains far from the 75th percentile of its industry group.
Other early warning signals paint a mixed picture
At the beginning of the pandemic, Boeing's one-year EDF measure began trending above its five-year annualized EDF value, resulting in an inversion of the EDF term structure from March 2020 until February 2021. Figure 5 plots the one-year (blue line) and the five-year (green line) annualized EDF measures for Boeing from 2019 to July 2021. This inversion of the EDF curve is a warning of near-term default risk, as a company's EDF term structure only inverts when we see greater risk of default during the short term than over the long term. As we see with previous Moody's Analytics research, companies with inverted EDF term structures default at a two to five times higher rate compared to firms that do not.3 Although the term structure has remained normal for the past five months, the one-year and five-year EDF values remain somewhat close, so we monitor this indicator closely.
One of the most powerful early warning signals of default risk compares a company's EDF measure with the industry's early warning trigger level. When a company's one-year EDF approaches and crosses the trigger level, it indicates elevated risk of default compared to other firms within its sector. Trigger levels are industry sector and country-specific.
Figure 6 compares Boeing's one year EDF (blue line) to its trigger level (green line). Despite the sharp increase in Boeing's one-year EDF in response to the pandemic, Boeing's probability of default remained consistently below its sector trigger level. Because the trigger level intends to flag firms that are relatively riskier, trigger levels move as the overall risk of a sector changes. The jump in the EDF trigger level (green line) in March 2020 is yet another sign that the pandemic had a strong impact on the U.S. Aerospace and Defense Group, and that the sector has been improving ever since.
Taken together, the early warning signals paint a mixed picture for Boeing. Its relative EDF level (Figure 3} and the fact that it did not trigger an early warning alert (Figure 6) suggest that Boeing's rising credit risk, as captured by the sharp EDF measure increase, should not necessarily raise alarm bells. Offsetting these indicators is the inversion of the EDF term structure (Figure 5), often an early sign of relatively higher credit risk.
Assessing climate risk: climate-adjusted EDF measures
Looking beyond the immediate effects of the recent moves in Boeing's EDF, investors are also increasingly taking factors such as climate and ESG into consideration in their investment decisions. The rapid pace of climate change and the increasing likelihood of emissions-focused, transition-related policy action present important implications for firms across the globe. Specifically, Boeing may suffer damages to physical assets or disruptions to business models due to climate-related events. Additionally, carbon taxation, increasing fuel prices, along with new green technologies, pose future challenges as well as opportunities.
To account for future climate risks and potential impact on credit risk, Moody's Analytics has introduced a climate-adjusted EDF methodology. The climate-adjusted model integrates climate scenarios devised by the Network for Greening the Financial System (NGFS) to forecast Climate-Adjusted EDF measures.4
Figure 7 shows Boeing's Climate-Adjusted EDF measures projected for the next 30 years, with each line representing a different NGFS climate scenario. "Early Policy" assumes climate policies are introduced early and gradually become stricter; "Late Policy" assumes climate policies are not introduced until 2030, at which point stringent policies are implemented to sharply reduce emissions; "No Policy" assumes that no additional climate policies are implemented; "Quick No Policy" is based on the "No Policy" scenario and assumes a 95% percentile damage level due to climate change.
Comparing the four climate scenarios, Boeing's 10-year probability of default may potentially be reduced by adopting early governmental climate policies, and its 30-year probability of default may be significantly reduced by implementing new climate-related policies. These decreases in default probabilities suggest that Boeing may be well-positioned to take advantage of opportunities related to green technologies and business changes.
Climate-Adjusted EDF drivers
The calculation for a firm's Climate-Adjusted EDF measures can be broken down into "physical risk" and "transition risk." Physical risk includes the costs and risks arising from the physical effects of global warming to a firm's operations, workforce, markets, infrastructure, raw materials, and assets. For example, firms based solely in countries with low sea levels will face greater physical risk. Transition risk includes the costs and risks arising from the transition to a lower-carbon economy, taking into account factors such as governmental policy changes and shifts in market preferences. For example, firms in industrial sectors such as Coal - which has high carbon emissions - will face greater transition risk.
Figure 8 shows the impacts of physical and transition risk on Boeing's EDF projections separately. The graph shows that Boeing's ability to capitalize on climate policies will rely primarily on its ability to adapt to transition risk. Physical risk does not severely impact Boeing's operations and assets, with the difference in physical risk between Early Policy, Late Policy, and No Policy staying within 0.05% throughout the 30-year projection. Conversely, adoption of early climate policies as opposed to no new policies reduces Boeing's transition risk by 0.2% in 10 years and 0.3% in 30 years. In other words, Boeing's perceived ability to adjust to climate-related policy changes, such as carbon taxes/caps, regulations on goods and services, and climate-related shifts in market preferences and technologies is the main contributor to its projected lower PD, if government-implemented climate policies are introduced. For its part, Boeing has reported that it is already shifting its focus to reducing carbon emissions and finding alternate fuels for the company's operations. For example, new commercial airplanes are already 15% to 25% more fuel efficient than their predecessors. Furthermore, Boeing has pledged to have all its aircraft fly using 100% sustainable aviation fuel by 2030, which can reduce emissions up to 80% compared with conventional jet fuel.5
Conclusion
The 737 MAX grounding increased Boeing's liabilities, lowered asset values, and created greater asset volatility, all of which negatively affected its credit risk. The COVID-19 pandemic's impact on travel-connected industries resulted in greater asset volatility and further decreased asset value, which greatly raised Boeing's credit risk.
Despite mixed early warning signals, however, Boeing's EDF value changes have not raised a red flag of excessive credit risk. Boeing's EDF measure never crossed its trigger level, its EDF value has trended back to the median of its sector, and its term structure has normalized. Furthermore, with decreasing liabilities after completing 737 MAX-related payouts and increasing asset value due to new commercial orders and a return to profitability, the pressures elevating Boeing's one-year EDF measure have waned somewhat.
The EDF measures explored in this case study are ideally suited for evaluating the company's climate-related credit risks. Using NGFS climate scenarios, we examine how both physical and transition risks impact Boeing's probability of default in future decades. Investors increasingly need this information for both reporting and risk assessment purposes, and the Climate-Adjusted EDF methodology provides the granularity and transparency required. The Climate-Adjusted EDF measures for Boeing suggest that it may be well-positioned to take advantage of opportunities related to green technologies and business changes to help lower its future credit.
1 Implied ratings are calculated by finding the Moody's ratings associated EDF level bands on a given date. See "EDF Implied Rating Methodology Update," March 2015.
2 An overview of the EDF model can be found in "EDF9: Introduction and Overview," June 2015.
3 See "Using EDF Measures to Identify At-Risk Names-A Monitoring & Early Warning Toolkit," April 2016.
4 See "Assessing the Credit Impact of Climate Risk for Corporates," March 2021.
5 https:/ /www. travel weekly.com/Travel-News/Airline-News/Boeing-sets-a-timetable-for-going-all-green
