Corporate defaults soar as credit quality slides

Corporate credit quality in Western Europe is set to continue declining in 2002, in spite of downgrades already hitting record levels last year, according to a report by Moody’s Investors Service.

The corporate sector suffered 123 downgrades last year against just 16 upgrades, representing $458.2 billion and $24.1 billion of debt respectively. Last year the telecoms industry alone accounted for 37% of all corporate sector downgrades. Deterioration this year is likely to be more widespread, affecting already beleaguered sectors with negative rating outlooks, including transportation, hospitality, automotives and utilities, says the report.

Moody’s gloomy outlook reflects its expectations that asset values will remain depressed over the coming year, says Stuart Lawton, managing director for project finance, utilities, telecoms and oil & gas at Moody’s. “A lot of companies used the boom years to leverage up and make acquisitions,” he says. Now, for many, the cashflow from those acquisitions is not as good as they thought and they are left in a difficult position because the equity market is soft, which has reduced the opportunities to sell off non-core assets and pay down debt.”

But Moody’s does not expect the credit deterioration to be as dramatic as last year’s, with anticipated improvements in earnings, cost-reduction programmes and consolidation expected to slow the pace in the second half of 2002.

The downturn will have knock-on effects, says Lawton. “Credit deterioration goes hand in hand with a growth in the number of defaults, and we would expect to see the number of corporates defaulting rise over the coming year.”

Diane Vazza, head of global fixed-income research at Standard & Poor’s agrees. “Last year corporate defaults exceeded 200 for the first time globally,” she says, with 211 issuers defaulting on some $115.4 billion of debt. This figure dwarfed the previous record set in 2000, when 132 issuers defaulted on $42.3 billion of debt.

“In January this year [to the 23rd] there have already been ten defaults globally, totalling some $6 billion,” she adds. “Our economic view is that we’re going to be bottoming out this quarter and, typically, defaults in a cycle peak six months after that, in this case at the start of the summer. So there is definitely more to come, but the pace of defaults should ease by the end of the year.”