Wide Spread Trouble for Debt Markets

In 2001's first half, credit spreads will remain wide for investment-grade issues -- and will worsen in the junk market

Credit quality and liquidity concerns, coupled with increasing defaults, wreaked havoc on the U.S. corporate bond market in the fourth quarter, and both investment-grade and speculative-grade credit spreads widened significantly, Standard & Poor's said on Jan. 2. "Looking ahead to 2001, despite a widely anticipated Fed rate cut early in the year, investment-grade spreads will remain at wider levels in the first half of the year," said Diane Vazza, managing director and head of global fixed income research for the rating agency. "With more defaults on the way, speculative grade spreads will widen further before they firm in the first half of the year."

"Moreover, given the high level of speculative-grade issuance during the years 1997 through 1999 of $373 billion, we expect defaults to continue to rise in 2001," Ms. Vazza said. "That is because, coupled with a slowing economy, historically, defaults peak two to three years after high-yield issuance peaks. Defaults in telecommunications sector, with seven in 2000, are expected to rise as well."

Following a series of missed earnings reports in the third quarter of 2000, the bond market was put under a microscope, surfacing already pervasive weak credit quality, Ms. Vazza noted. Standard & Poor's Investment Grade Credit Index closed the quarter at 252 basis points more than comparable U.S. Treasuries -- 50 basis points wider than at the beginning of the quarter. The Standard & Poor's Speculative Grade Credit Index closed 250 basis points higher at 1,047.

The entire credit rating spectrum has experienced wider spread levels since July 1999 when the Federal Reserve raised interest rates six times — a total of 175 basis points. At that time, investment grade spreads were 140 basis points -- the same level at the start of 2000. During the year, investment grade spreads widened 112 basis points. In July 1999, speculative grade spreads were 470 basis points, widening to 530 basis points by the start of 2000. By year-end, speculative grade spreads almost doubled, widening by 517 basis points. Fifty percent of the movement alone was in the fourth quarter.

As a result of wider spread levels, primary market activity slowed considerably. For the quarter, 118 issues totaling $55 billion were sold versus 165 totaling $62 billion in the fourth quarter 1999. Of those done in fourth quarter 2000, only 12 issues totaling $3.5 billion were high yield versus 56 totaling $20 billion in the fourth quarter 1999. For the year, 684 issues totaling $293 billion were sold versus 1,133 issues totaling $354 billion in 1999. Of those issues sold in 2000, 163 totaling $54 billion were high yield versus 407 totaling $106 billion last year.

Credit quality continued to show no signs of improvement. At 0.22, in the fourth quarter, the investment-grade industrial credit ratio (number of upgrades divided by downgrades) had ten consecutive quarters when the number of downgrades exceeded that of upgrades. The high yield credit ratio was .20, also the tenth consecutive down quarter. In the last sustained downturn (1990-1991), both investment grade and high yield had 11 consecutive down quarters. During that period, the investment grade credit ratio hit a low of .24 in the third quarter of 1990 and the high yield credit ratio hit a low of .15 in the fourth quarter 1990. In 2000, for industrial, 108 issuers ($81.2 billion) were upgraded and 463 issuers ($348.3 billion) were downgraded.

Subsectors with the most downgrades within the investment-grade arena were consumer products, forest products, media and entertainment and retail/restaurants. Within speculative grade, hardest hit were autos and suppliers, capital goods, chemicals, consumer products, forest products, healthcare, media and entertainment, metals and mining, retail/restaurants and transportation.

In telecommunications, seven issuers ($11 billion) were upgraded and 17 issuers ($108 billion) were downgraded within investment grade. Within speculative grade, 10 issuers ($11 billion) were upgraded and 25 issuers ($24 billion) were downgraded.

In utilities, ten issuers ($19 billion) were upgraded, while 25 issuers ($36 billion) were downgraded; in the bank sector, three ($1.6 billion) were upgraded, and two ($442 million) were downgraded; in financial institutions, nine ($44.4 billion) were upgraded and 24 ($84 billion) were downgraded; in insurance; 6 ($3 billion) were upgraded and 33 ($22 billion) were downgraded. Sovereigns were the only improving sector, with ten investment-grade upgrades (no downgrades) and 13 speculative-grade upgrades and eight downgrades.

Defaults on rated issuers accelerated in the fourth quarter with 35 bond issuers, totaling $17.3 billion, defaulting. Hardest hit in the fourth quarter were consumer products and metals and mining with 10 and 5 defaults, respectively.

For 2000, 106 defaults ($33.4 billion) on rated bond issuers exceeded 1999's previous record of 89 issuers ($24 billion). In 2000, 18% of the defaulted issuers were in consumer products and 13% were media and entertainment, Standard & Poor's said.

From Standard & Poor's CreditWire

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