Credit cycle turning, say ratings firms

Ratings agencies are warning that a turn in the credit cycle could be on the horizon, with downgrades projected to outpace upgrades as soon as the third quarter. "We're now seeing more of a downside and downgrades coming through on cyclical sectors. It was pretty much expected from last year when we saw a trough in default rates, but we now see through the rating statistics that the best situation is now past," says Guillaume Menuet, senior economist at Moody's Investors Service.

Dramatic change, however, is not expected, despite a rise in defaults being forecast. "The conditions remain benign. However, we do expect certain deterioration in credit quality, primarily because of the very high volume of high-yield business that came around last year. Some of that is certainly going to create some surprises," says Jean-Michel Six, an economist at Standard & Poor's in London. Six also expects banks to tighten up on lending over the next few months, which could add to corporates' credit problems.

Using data and statistics compiled from Moody's ratings watch-list, Menuet sees ratings trending downward. It takes between three and four months for an issuer placed on the watch-list to have its ratings changed. "The signal from the watch-list at the end of last year was we thought credit conditions would continue to improve until April, as it has," remarks Menuet. "If you look at the ratings watch-list now, credit quality could be showing signs of flagging slightly. It's a bit of a stretch to say at this stage that downgrades will outstrip upgrades as early as the third quarter, but the direction is suggesting that we've come off the peak."

The analysts point to the weak eurozone economy as being problematic. In addition, Six says it remains very difficult to assess effects of the General Motors and Ford downgrades in the short term. "Although it was telegraphed quite well, and I think that the markets by and large were expecting this, the way it's been absorbed is not behind us. It's something the markets are still digesting," he says.

Rachel Wolcott