Capital Markets

Moody’s: Credit Quality Headed for a Fall

Worldwide, credit quality improved last quarter. But North American firms appear poised for more downgrades than upgrades.
Stephen TaubJuly 26, 2006

Global corporate credit quality improved in the second quarter of 2006, according to a new report from Moody’s Investors Service.

The credit rating company said the ratio of global upgrades to downgrades stood at 1.6 during the second quarter, much higher than the 1.2 ratio recorded during the first quarter as well as the fourth quarter of 2005.

However, it noted that the bulk of the improvement in credit quality was driven by rating actions in the Asia-Pacific and Latin American regions, where it says upgrades “sharply” exceeded downgrades.

Average credit quality improved only modestly in North America, where upgrades only slightly outpaced downgrades. Even so, Moody’s points out that this reverses the trend over the last two quarters in which downgrades exceeded upgrades.

Yet Moody’s also warned that North American credit quality is likely to decline somewhat over the next several quarters, given the current distribution of rating reviews and outlooks. Although the percent of North American issuers that were upgraded during the most recent quarter (3.9 percent) exceeded the 3.7 percent that were downgraded, the end of the quarter also saw about 5 percent of issuers on review for downgrade. Only 1.7 percent were on review for an upgrade.

What’s more, substantially more issuers in North America had negative outlooks (11.7 percent) than positive outlooks (7.5 percent), —suggesting a decline in credit quality over the next few quarters — the rating agency added.

Most of the rating actions, both upgrades and downgrades, were concentrated in the mid-range — low-investment-grade to high-speculative-grade — of Moody’s rating spectrum and were fairly evenly distributed across various rating categories in that range.

Issuers on review for upgrade and downgrade were also mainly concentrated in the mid-range of Moody’s rating scale, it added.

A far larger proportion of issuers rated speculative-grade had negative outlooks than positive outlooks in the second-quarter of 2006. “The overall picture also presents a slightly pessimistic view,” Moody’s notes, as more issuers have a negative outlook (9.7 percent) than a positive outlook (8.2 percent) at the end of June 2006.

Globally, virtually all industries had more issuers with negative outlooks than with positive outlooks, according to Moody’s, adding that aerospace, automotive, and forest products currently are under the most pronounced pressure.

In the last quarter alone, the automotive industry, building materials, and telecoms had significantly many more downgrades than upgrades.

On the other hand, Moody’s points out that the industries for which credit quality improved significantly were thrifts, utilities, airlines, metals and mining, and banking.