High yield credit quality worsens in January with no sign of future improvement, Moody's says

New York, Feb. 5 - Credit quality of high yield issuers deteriorated in January with the month's 35 downgrades exceeding the seven upgrades by a five-to-one margin, according to Moody's Investors Service.

That ratio was worse than the four-to-one level recorded for the fourth quarter.

And damping down any hope of a near-term improvement, the rating agency's analysts also noted unfavorable signs among leading indicators; there were far more reviews for downgrade than reviews for upgrade and more unfavorable outlook changes than favorable. Indeed the ratio of reviews for downgrade to reviews for upgrade sank to its lowest level in more than 10 years, according to Moody's.

"Both reviews and outlook changes suggest credit risks will remain elevated through the first half of 2002, at least," commented Moody's analyst John Puchalla in a new report.

"The US economy has shown tentative signs of pulling out of the recession but significant pressures on corporate credit remain," Puchalla wrote. "Weak corporate earnings, soft demand, excess capacity and tight liquidity helped credit rating downgrades far outnumber upgrades in January. A firming of credit worth implied by the recent narrowing of yield spreads will not materialize until and unless demand and corporate earnings rebound."

Among the downgrades, two companies had their ratings lowered more than once, accounting for seven of the 35 high-yield downgrades. Kmart Corp. saw its ratings cut four times and Covanta Energy Corp. was downgraded three times.

Telecom was the weakest sector in January with eight downgrades and one upgrade, Moody's said. The rating agency attributed the industry's poor performance to slow or negative revenue growth, excess industry capacity that also weakened asset values, poor performance from overseas operations, IT capital spending cuts and fewer new customers.

Liquidity was also a problem in telecom because many companies have little or no availability under bank credit facilities and very little flexibility under loan covenants, Moody's said.

However it noted that the "decent" level of speculative-grade bond issuance in January provided some relief to issuers. A cellular phone company was upgraded after using proceeds of a new bond and cash flow to pay down a credit facility, which now takes up a smaller share of the capital structure. A supplier of electrical equipment had its outlook raised to stable from negative as proceeds from bond and asset sales prepaid two years of bank facility amortization while also allowing for a relaxation of loan covenants.

For all corporate issuers, investment- and speculative-grade, downgrades exceeded upgrades by 54 to 12, according to Moody's.

In the investment-grade sector, the downgrade-to-upgrade ratio was 3.8 to one (19 downgrades for five upgrades), weaker than the two-to-one ratio in the fourth quarter.

Of the investment-grade rating reductions, the hardest-hit sector was casinos due to weaker business and leisure travel, exposure to the Las Vegas market, increasing competition in Las Vegas related to forthcoming supply and equity buybacks.

Moody's also noted that the overall credit picture is even worse if dollar values are examined instead of numbers of issuers.

January saw $200 billion of debt downgraded compared to $4.9 billion of upgrades. Even excluding the $139.8 billion of Ford debt that was lowered, the dollar amount of downgrades still beat upgrades by a $12.4 to $1 margin.

Moody's noted that December saw $175.3 billion of downgrades and the monthly average for 2001 was $79 billion. Average monthly upgrades last year were $35 billion.

After Ford, the biggest rating reductions in January were National Rural Utilities Cooperative Finance ($10.7 billion), Conseco, Inc. ($6.1 billion), Kmart ($4.7 billion, counting par value once although there were four downgrades) and Williams Communications Group ($3.3 billion).

January's largest upgrade was Amazon.com Inc. at $2.2 billion.

Looking ahead, reviews and outlooks do not paint a positive picture, Moody's said.

"The number of potential upgrades withered away in January, hinting that debt coverage and credit worth have yet to show a definitive recovery," according to Moody's analyst Kamalesh Rao.

Moody's put only three companies on review for upgrade, the lowest level since 1992.

By comparison, December saw 13 companies put on review for upgrade and the monthly average for the fourth quarter was 11 and for last year 16.

Meanwhile 51 companies were put on review for potential downgrade in January, up from 41 in December although in line with the monthly average of 53 for the fourth quarter. For last year as a whole, the monthly average was 47.

However Rao noted the pace of downgrade reviews has eased from a peak of 88 in October and 78 in September.

The ratio of reviews for upgrade to reviews for downgrade was less than 0.1:1.0, Moody's said, the lowest level in more than 10 years. For 2001, the ratio was 0.3:1.0 and for 2000 it was 0.43:1.0.

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