Downgrades of high-yield bonds are outpacing upgrades so far this quarter, in an early sign the credit cycle may be signaling an end to the high-yield party, said John Lonski, chief economist at Moody’s Investors Service. The ratio of upgrades as a percentage of total rating actions for this quarter currently sits at 38%. That’s the lowest level of the year, compared to 58% last quarter and 56% for the second quarter. “It would be premature to conclude that upgrades’ share will rise no more...but these numbers are still a warning sign,” Lonski said.
And in what some market players called an unusual twist, a recent report from Lonski included his views on valuations. “Historical records suggest spreads are well under; chances are, over time, they will be wider,” he said. One investor said it is noteworthy that Moody’s, which normally does not promulgate its views on spreads, is now saying they are due to widen.
Lonksi said he is so conservative on high-yield because Caa-rated paper constitutes such a large share of the current high-yield market.
Another high-yield veteran noted he had seen some Moody’s commentary on pricing here and there but nothing so extensive as in recent weeks. “It was genuinely a little odd. I thought they’re probably trying to support that they’re not upgrading quickly,” he added, speculating Moody’s may be offering its views on spreads now to bolster confidence in its ratings. He noted 18% of the market is rated triple-C yet there is a prevailing 2% default rate, which has left some high-yield professionals to question whether Moody’s is too conservative.
