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Corporate Supply&Flows (FEBRUARY 19)

The trend improvement in rating actions continued during January as the number of downgrades fell yet again and this time to a level not seen since January 1998.










CreditSights: Upgrades Outpace Downgrades

The trend improvement in rating actions continued during January as the number of downgrades fell yet again and this time to a level not seen since January 1998. According to Moody's Investors Service, there were 21 downgrades in the month of January. The industrials sector accounted for 17 of them, while the financial and utility sectors delivered two apiece. They were heavily biased toward speculative-grade credits and indeed, there were only three investment grade downgrades. The credit quality upswing has yet to gain a lot of traction in terms of rating upgrades however. 22 companies received upgrades in January, compared to 30 in December, and although this pace is ahead of the 2003 run rate of just 17 upgrades per month, it is indicating we have some way to go yet before rating realities equal the pricing realities of the last 18 months.

Similar to what was seen with downgrade actions, upgrades were biased to the speculative-grade sector, which accounted for 17 of the 22 actions. Despite the ongoing minimal occurrence of upgrades however, the month was notable in that the number of upgrades did manage to exceed the number of downgrades, even if only by a single action. This was repeated in that there were no fallen angels in January, but there was one rising star.

The recent activity in ratings review is even less encouraging. 18 reviews for downgrade easily outnumber five reviews for upgrade. Rating reviews can be volatile and drawing correct inferences from them on an aggregate basis can prove difficult. It is worth noting however, the particular concentration of the latest batch of negative reviews in the oil and gas sector, which accounted for seven of the 18 reviews for downgrade.

A pleasing ratings development so far this year comes in the form of the number of upgrades off the back of announced mergers and acquisitions. M&A volumes are increasing rapidly and the trend looks set to continue throughout 2004. According to Bloomberg data, announced North American deal volumes for the first two weeks of February alone at $99.5 billion already exceed January totals and the deals are coming from a diverse range of industries. Given the potential for the agencies to look askance at any transactions that are less than prudently financed, present significant synergistic hurdles, or are likely to increase the volatility of earnings, that recent M&A announcements have established themselves as a net benefit to ratings is welcome news.

Moody's reported that to mid-February there had been nine M&A related rating actions, eight of which had been upgrades, affecting $6.35 billion in debt. The sole downgrade affected just $175 million in debt. It is reasonable to assume that such a trend merely reflects acquisitions by higher-rated companies, but Moody's analysts have noted that some of the upgrades were divestiture-related and others reflected improvements to the capital structure post the transaction. Of the eight companies upgraded, five were speculative grade, but so too was the sole downgrade.

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