2002: Debt Valley Days

Borrowing costs may have been almost nil, but corporate credit took a big hit last year.
Stephen TaubJanuary 2, 2003

Borrowing costs may have dropped to microscopic levels in 2002. But, it was still a lousy year for companies with outstanding debt.

In fact, 2002 set a record for credit-rating downgrades, breaking the previous record set in 2001, according to Moody’s Investors Service. What’s more, there were fewer credit upgrades last year than in any twelve-month period since 1991.

Specifically, 747 publicly traded companies had their credit ratings cut in 2002 — two more than the prior year’s total, according to Moody’s chief economist John Lonski. The sectors with the most downgrades? No big surprises there: wholesale electric power, telecommunications, and technology specialists. If you exclude those three groups, the number of rating reductions would have actually fallen 16 percent last year.

Moody’s lifted the ratings for a mere 129 borrowers in 2002, the fewest upgrades in more than a decade. By comparison, Moody’s upgraded the credit ratings on 219 companies in 2001 — not exactly a banner year itself for corporate creditworthiness.

What’s more, only five investment-grade companies enjoyed rating increases in the fourth quarter of 2002, the worst quarterly showing in Lonski’s records, which date back to 1986. According to Bloomberg, the previous low came during the fourth quarter of 1987, when just six companies received increases.

Interestingly, sub-investment-grade bonds enjoyed 20 ratings increases in the fourth quarter, Lonski told the wire service.

The credit picture looks a lot brighter for next year, however. For starters, a lot of companies are improving their accounting practices. In addition, few corporations have been borrowing money of late — and those that do have taken advantage of the record-low interest rates.

“You’ve had so much borrowing restraint take effect, with companies managing their debt more conservatively and benefiting from lower borrowing costs,” Lonski told the wire service. “If these forecasts for an improving economy prove to be true, chances are you are going to have fewer downgrades and more upgrades in 2003.’”

One indication that lenders are warming up to corporate credits: the risk premium for investment grade bonds (the interest rate above Treasuries) is around 1.86 percentage points. That’s down from a decade high of 2.67 percentage points on Oct. 10, according to Merrill Lynch. The average risk premium for junk bonds shrank to 8.82 percentage points from 11 percentage points.

One big reason is that investors continue to move into junk bond mutual funds. During the week ended last Wednesday, investors pumped $341 million into these portfolios, matching the prior week’s inflow, according to AMG Data Services.

In fact, junk bond mutual funds have enjoyed net inflows during 10 out the last 11 weeks, according to AMG.

It’s not coincidental that during that period, junk bond mutual funds have been staging a long-predicted rally.


As a result, the average yield on junk bonds is around 12.09 percent – a whopping return by today’s standards.