Capital Markets

Credit Quality Improves, for Now

Standard & Poor's reports that company credit ratings improved last quarter, but earlier warnings of increased defaults still loom
Stephen TaubApril 6, 2006

Credit quality improved in the first quarter, according to a new study by Standard & Poor’s Ratings Services.

The conclusions are based on the credit rating agency’s analysis of rating upgrades and downgrades. In the first quarter of 2006, S&P counted 129 upgrades and 130 downgrades. That’s an improvement over the 117 upgrades and 148 downgrades in the fourth quarter of 2005.

As a result, S&P’s global corporate downgrade ratio — defined as the ratio of downgrades to total rating actions — improved to 50.2 percent in the first quarter from 55.8 percent in the preceding quarter. (A lower number represents fewer downgrades as a percent of the total, and thus is an improvement).

The US played a big role in this improvement. S&P reported that the U.S. was the only region to show a sharp up-tick in first-quarter upgrades, to 78 from 54 in the fourth quarter.

In dollar terms, the first-quarter downgrades represented ratings on debt worth $441.2 billion, less than half the sum recorded in the fourth quarter of 2005. Better yet, the value of the first-quarter upgrade amount increased, coming in at $260.1 billion compared with $239.2 billion in the prior quarter.

S&P’s upbeat report is in stark contrast to a report issued in late March, which found that the number of companies at risk for potential credit-rating downgrades jumped to a high of 659 in mid-March, compared with 636 in mid-February. The rating agency warned at the time that the number represents the highest level since the rating agency began preparing the report last September.

That warning still looms. In this latest report, S&P notes that the new downgrade ratio of 50.2 percent is still a deterioration from the 47.9 percent recorded in the first quarter of 2005, when there were 134 upgrades and 123 downgrades. And S&P continues to warn about an impending deterioration in credit quality later in the year.

“Though the sharp rebound in U.S. GDP growth has helped improve credit quality, we expect growth to moderate as the year progresses,” the report predicts.

S&P acknowledges that the combination of strong global corporate balance sheets and very strong cash positions has limited bond issuance until now. However, it notes that shareholder friendly activity — such as share buybacks and increased dividend payouts — coupled with more aggressive expansion plans, will require companies to enter debt markets more heavily, causing leverage to increase.