Moody's sees signs of possible bottom to credit cycle

New York, March 11 - Corporate credit quality is likely to continue to deteriorate for the rest of the year but the first indications are emerging that current cycle is reaching bottom, Moody's Investors Service said Monday.

Ratings reviews and outlook changes both suggest downgrades will continue upgrades for the remainder of 2002, the rating agency said.

But outlooks - which look further ahead than reviews and are less susceptible to special events - indicate the rate of deterioration in credit quality is slowing and figures for March so far show there have been more positive than negative outlook changes for speculative-grade firms, Moody's said.

However, the rating agency stresses: "We caution that the recent improvement in outlook changes is too preliminary to be considered a definitive trend. However, it is a very encouraging credit sign."

For 2002 so far, there have been five reviews for upgrade compared to 60 reviews for downgrade, Moody's said. That is a worsening from the fourth quarter of 2001, when there were 108 reviews for downgrade against 26 reviews for upgrade.

Moody's said the trend has been driven by the sharp drop in merger and acquisition activity this year. M&A, equity offerings, share repurchases and similar special events tend to drive rating reviews, Moody's explained.

In the fourth quarter of last year, 18 of the 26 reviews for upgrade were linked in part to M&A but the number has fallen to just three so far this year. The 26 reviews for downgraded linked to M&A in the fourth quarter is closer to the 17 so far this year.

Other factors contributing to reviews for downgrade are the drop in capital spending - especially for high tech industries - weaker cash flows, high operating leverage and pressure on product pricing. Lower revenues and a strong dollar have led to reviews for downgrade of manufacturers with a high degree of fixed costs, Moody's added.

However, Moody's sees a positive indication in the reviews because they indicate that corporations are moving away from some of the riskier activities that were a drag on credit quality in the late 1990s. Only two companies have been put on review for downgrade in 2002 in connection with equity buybacks, down from six per quarter over the last two years.

Meanwhile, for 2002 so far there have been 37 unfavorable outlook changes compared to 19 favorable outlook changes, Moody's said.

Those figures are an improvement on the fourth quarter of 2001 when there were 54 unfavorable outlook changes and just 12 favorable outlook changes.

"Recent gains were most notable in the more earnings-sensitive speculative-grade sector. Efforts to reduce debt and improve financial flexibility have also contributed to an increase in the number of favorable outlook changes this year," Moody's commented.

Recently the improving trend has been more pronounced, the rating agency said.

For March so far, there have been five favorable outlook changes for junk-rated firms against three unfavorable changes.

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