One of the more interesting [read: useful] bits of Standard & Poor’s is their Global Fixed Income Research unit, led by Diane Vazza in New York.
Take these snippets from the unit’s latest report on the prospects for US high-yield debt (emphasis FT Alphaville’s):
Credit quality continued to deteriorate in February, with downgrades outpacing upgrades 49 to 6 in the first three weeks of the month. So far in the first quarter downgrades are outpacing upgrades 14.3 to 1. If that pace continues, first-quarter 2009 would be the worst quarter on record in terms of this ratio. Downgrades to upgrades were 8.9 to 1 in the fourth quarter of 2008 and reached an all time high of 14.1 to 1 in the fourth quarter of 2001. We expect that downgrades will far outpace upgrades over the next few quarters, as the proportion of firms with ratings on CreditWatch negative or with a negative outlook (or negative bias) reached an all-time high of 42%, while positive bias reached an all time low of 7% (data series starts in 1990).
Economic weakness is having an ever-widening impact across sectors. In 2008, consumer sensitive sectors, such as automotive, retail and restaurants, and consumer products, saw numerous downgrades, while more upstream sectors such as capital goods; metals, mining, and steel; and oil and gas had relatively benign number of downgrades.
However, even sectors that held up relatively well in 2008 have begun to see an uptick in downgrades, as profits and financial measures in these sectors erode. Indeed, industrial production and capacity utilization have fallen sharply in the manufacturing sector, as has the prices of many commodities used as inputs into the production process. As demand has weakened, the outlook for credit quality in the capital goods; metals, mining, and steel; and oil and gas sectors has dimmed.
The sectors with the largest proportions of companies with negative bias are homebuilders/real estate (78%), automotives (77%), forest products and building materials (67%), finance companies (61%), transportation (61%), and media and entertainment (58%).
Sectors with the highest upgrade potential based on positive bias include telecommunications (14%); utilities (14%), high technology (13%) and aerospace and defense (13%).
The first half of February saw seven new issues worth nearly $3 billion hit U.S. markets (see table 3). All but one issue were from companies rated at or above ‘BB-’. We expect that investor sentiment toward the primary market will remain volatile, which will keep the primary market rocky in the next few quarters. Companies rated lower than ‘BB’ or in an industry with riskier earnings prospects will not be assured a quick placement of debt.
Let’s step back for a moment. On the one hand, there have been signs of a thaw in certain credit market indicators; on the other hand, savvy credit investors have been bracing themselves for record corporate defaults.
Moreover, some crisis indicators are inching back up toward ‘danger’, as the Wall Street Journal noted in a story on Monday. Hedge funds’ new-found appetite for gold doesn’t inspire confidence either.
Elsewhere, as SocGen’s Suki Mann points out in a note:
The [CDS] indices are at record highs, with the Main underperforming the X-Over; the financials indices have jumped higher with the sub/senior ratio hitting 2x at one stage last week; bank cash hybrid debt is trading at distressed prices with price action/flow dynamics being likened to the corporate high yield market; and we’re seeing the first signs of a dislocation in the upper part of the investment-grade debt market.
But do these metrics suggest a generalised collapse in confidence or just a rightfully restrained approach to risk? Both, and neither.
Both, because many investors are panicked and unsure of where to turn, and because even those who have kept their wits about them are proceeding with extreme caution.
And neither, because by any measure this is a new world for credit, one that represents a system-wide repricing of risk and a redifinition of reward and makes comparisons with such halcyon days of yore (like, say, 2006) misleading and, in extremis, irrelevant.
Corporate credit, the pachydermic herd in the room – FT Alphaville