Capital Markets

Credit Quality Continues to Improve

The downgrade-to-upgrade ratio is much better in Europe than in the United States and Canada, but many more European issuers are on watch for downg...
Stephen TaubJuly 19, 2004

So much for rising interest rates. Capping a week of jumbo debt offerings, Morgan Stanley issued $4.25 billion in two-part extendible floating-rate notes — the largest offering so far this year.

In addition, Freescale Semiconductor Inc., a spin-off of Motorola Inc., trotted out $1.25 billion of three-part notes in the private placement market, led by Goldman Sachs & Co., Citigroup Global Markets, Inc., and J.P. Morgan. The offering includes $500 million in 10-year notes, $350 million in 7-year notes and $400 million in 5-year notes.

The offerings come the same week that Moody’s published a report noting that global credit quality is showing increasing stability. The rating agency pointed out that there were slightly more upgrades than downgrades in the second quarter of 2004. This was the second consecutive three-month period that upgrades exceeded downgrades.

Just one year ago, Moody’s added, downgrades outnumbered upgrades by 3.2-to-1. What’s more, at the end of the first half of 2004, the percentage of all rated global issuers with negative outlooks stood at 14.1 percent, way down from 18.8 percent just six months ago.

“The share of issuers with positive outlooks or on watch for upgrade has been steadily growing, while the share of watches for downgrade has been fairly stable since the beginning of the year and has decreased sharply from a year ago,” wrote Moody’s analyst Hong Sherwin.

During the past three months, downgrades continued to exceed upgrades in the United States and Canada, but only slightly. The downgrade-to-upgrade ratio stood at 1.04 for the quarter, way down from 2.8-to-1 just one year ago. The picture is much brighter in Europe, where the downgrade-to-upgrade ratio came in at 0.8, down from 2.6 of a year ago. However, Moody’s pointed out that 2.6 times as many issuers in Europe are on watch for downgrade than for upgrade, “suggesting that the fast upswing in improved rating actions could face some pressure,” according to the report.

From an industry standpoint, Moody’s pointed out that the recent rapid increase in upgrades in the broad financial sector seems to have slowed; the sector’s share of quarterly upgrades dropped from 38 percent in the first quarter to 19.6 percent in the second quarter.

Of all financial-oriented companies, the insurance sector — both life and non-life — accounted for 77 percent of all downgrades. Non-life-insurance companies recorded the highest rate of downgrades among issuers over both the last three months and the last year, Moody’s added. “However, the insurance sector may soon turn a corner as rating reviews for upgrade currently exceed those for downgrade, and their share of all negative outlooks fell from 22 percent to 15 percent,” wrote Hong.

She also predicted more upgrades than downgrades for so-called crossover issuers that are rated at the lowest investment grade, Baa3, or the highest non-investment grade, Ba1. “Rising stars” should outnumber “fallen angels,” she added.

Investors seem more confident as well. Last week, U.S. junk-bond mutual funds experienced a $340 million inflow, the third consecutive week of inflows, according to AMG Data Services. The prior week, those funds received $436 million in assets.