Banking & Capital Markets

Credit Worth Still in Decline

Moody's says downgrades outnumbered upgrades by nearly five-to-one; highest ratio since 1990. Elsewhere: are the days of cheap money coming to an e...
John GoffApril 15, 2002

The U.S. economy may be in recovery, but you’d never know it by the credit ratings of U.S. corporates.

Moody’s Investor Services reports that it downgraded the ratings of 159 corporations in the first quarter of 2002. The downgrades affected $314 billion of corporate debt.

By comparison, Moody’s upgraded the ratings of only 34 companies, affecting $24 billion of borrowings. The ratio of downgrades to upgrades — 4.7-to-1 — is the greatest decline in corporate credit worth since the fourth quarter of 1990, when downgrades exceeded upgrades by a 6.3-to-1 margin.

Moody’s also notes that, with the general lack of M&A activity, Q1 marked the fewest number of corporate upgrades in a decade. In addition, unfavorable rating outlook changes (from stable to negative or positive to stable or negative) topped favorable outlook changes (from stable to positive or negative to either stable or positive) in the first quarter.

Subpar corporate earnings, triggered in party by amid excess production capacity, should lead to more downgrades than upgrades for the next few months. Further, Moody’s analysts point out that tighter lending standards, plus a weak equity market, will likely keep capital in short supply for problem credits.

For silver-lining seekers: the gap between the 43 unfavorable and 25 favorable outlook changes during Q1 was much narrower than in the fourth quarter of 2001. In that quarter, there were 54 unfavorable outlook changes and 12 favorable changes. Says Moody’s economist John Puchalla: “Improved operating cash flow, lower debt relative to EBITDA, lower interest expense, an debt reduction contributed to the stable to positive outlook changes for many corporations.” Divestitures, reductions in high-priced loans, and the paying down of short-term debt led to the lower number of unfavorable outlook changes.

In fact, despite the 4.7-to-1 ratio, Moody’s analysts believe corporate credit worth actually hit an uptick. Notes Moody’s Chief Economist John Lonski: “A rebound in corporate profits and capacity utilization should help to narrow the gap between upgrades and downgrades.” Adds Lonski: “Assuming a containment of hostilities in the Middle East, including the absence of destabilizing terror attacks elsewhere, by the final quarter of 2002, cash flows might recover by enough to help lift credit rating upgrades from their latest … low.”

That’s a big if.

Summer’s Coming; Rate Hikes Too?

Ah, summer. Leisurly walks on the beach, grilled corn, twi-night doubleheaders. Higher interest rates.

Yes, higher interest rates. After nearly two years of falling borrowing costs, interates rates may be headed in the other direction — and soon. According to a Bloomberg News survey, 10 of Wall Street’s largest bond dealers now believe the Federal Reserve Bank will boost overnight bank interest rates in late June to avert a spike in inflation. Last month, only five economists at the 22 primary dealers who trade directly with Fed thought the central bank would be stepping in anytime soon.

According to the Bloomberg survey, eight of the 10 economists said the Fed will boost its target for overnight bank loans by 25 basis points, up to 2 percent. The other two predict a half-point increase.

Currently, the federal funds futures market indicates that traders think there’s a 95 percent chance of a quarter-point increase come June. The Federal Open Market Committee (FOMC) next meets on May 7, then June 25.

In case you’re counting, the central bank lowered its target for the federal funds rate 11 times last year. The first decrease commenced in January, from 6.50 percent to 6 percent. The FOMC has not raised the fed funds target rate since May 16, 2000.

Whole Lot of Borrowing

>> On Thursday, AT&T Wireless Services Inc. priced $3 billion worth of global bonds, with yields as high as 8.125 percent. The offering consisted of three tranches: $250 million of 3-year notes were issued with a coupon of 6.875 percent; $750 million of 5-year notes issued with a couponof 7.5 percent; and $2 billion of 10-year notes were issued with a coupon of 8.125 percent. The interest rates on the AT&T debt were slightly highe than some industry watchers had first anticipated. Moody’s Investors Service rates AT&T Wireless’ long-term debt Baa2. Standard & Poor’s rates it BBB.

The funding, which is expected to close on April 16, comes one month after AT&T Wirelesss management warned the company would miss Wall Street projections for 2002 operating cash flow and service revenue growth. In addition, wire services have reported that AT&T Wireless is engaged in merger talks with rival Cingular Wireless. Talks are said to be preliminary and no transaction is imminent. Cingular is owned by former Baby Bells SBC Communications and BellSouth.

>> Freddie Mac reported it sold $6 billion of two-year reference notes in an Internet-based Dutch auction at a lowest accepted rate of 3.825 percent. The 3.750 percent notes were priced at 99.8569, according to the company. In a Dutch auction, successful bidders pay only the price of the lowest accepted bid.

>> Household Finance Corp. filed a shelf registration to borrow up to $10 billion in senior debt securities. The financial services company plans to use the proceeds for investments, credit extensions and debt reduction.