Credit stress not as bad as a few years ago


For all the hand-wringing on Wall Street and in Washington about tight credit, Moody’s Investors Service says the credit quality of North America’s non-financial companies is holding up pretty well. Moody’s says that although credit quality has been declining, the trend is “far less severe than it was before the last sharp upturn in the default rate in 2000-2002.” Moody’s is currently predicting the default rate for North American speculative-grade companies will rise nearly five-fold from its current extremely low level of 1.0% to 4.7% over the next year. This is a dramatic increase but the expected rate is still less than half the level of the 11.0% peak in January 2002 during the last credit downturn.

"We expect the broadly negative trend we have seen in credit ratings this year to continue, but not to dramatically worsen unless a recession occurs," said Moody’s Chief Credit Officer for Corporate Finance Daniel Gates.

Gates says there are three broad concerns for credit quality: the deteriorating macroeconomic outlook, the effects of tighter borrowing conditions, and areas of softness in consumer spending. Credit quality is most vulnerable in the large population of low rated issuers. "Time is running out for a sizeable number of companies with high leverage and negative cash flow. Companies that negotiated loose covenants during the era of easy credit may have bought more time before being forced to restructure but negative cash flow can’t be sustained indefinitely for any of these companies," said Gates.

As you would expect, homebuilding is identified by Moody’s as the worst sector by a wide margin. Over 90% of homebuilders have negative outlooks or are under review for downgrade – nearly three times the percentage for the second ranking industry, building materials, for which the combined percentage is 33%. The restaurant sector ranks third, with negative outlooks or reviews for downgrade for 32% of issuers, reflecting concerns that consumer spending, although surprisingly resilient so far, is finally beginning to weaken.