ResearchMarch 20, 2019

Moody’s Downgrades Rise, Amid Towering Corporate Debt

Downgrades continue to outnumber upgrades, although interest coverage seems stable enough, for now.

Reported by Larry Light

Corporate America is looking at a rough patch ahead as earnings forecasts dip. But a bigger concern is the debt load that US companies carry. And the ongoing trend toward credit downgrades is not an inspiring signal.

So far in 2019, there have been 94 downgrades as opposed to 75 upgrades, for a ratio of 0.77, Moody’s data indicate. That ratio, wrote Mark Holman, CEO of TwentyFour Asset Management, a unit of Vontobel Asset Management, in a report, “is not an alarming figure, but it is becoming a trend.” Last year’s fourth quarter had a lot of downgrades and a 0.79 ratio.

At this stage, interest rate coverage remains solid. For US nonfinancial companies, earnings before interest and taxes cover almost four times interest expenses, a Federal Reserve study shows. Nevertheless, the level of corporate debt is daunting, totaling more than 70% of gross domestic product, higher than in 2007, right before the Great Recession.

A large amount of corporate issues now are rated as junk or near-junk. Consider coal miner Cloud Peak Energy, which Moody’s last month downgraded to Ca from Caa1. Both ratings are below investment grade, with the new one worse. Cloud Peak specializes in unearthing coal for the electric power industry. It figured that its mines in Wyoming and Montana would be a constant source of manna.

The trouble is that public utilities are increasingly converting to clean natural gas. This has left Cloud Peak with a diminished customer base. A decade ago, coal made up half the fuel for power plants, and that has been cut to 25%.

Meanwhile, Bank of America continues its comeback from a near-demise due to the financial crisis. The banking giant was weighed down by its purchase of Countrywide, a large provider of sub-prime mortgages, which defaulted epically in the finance meltdown. Moody’s upgraded BofA to A2 from A3. Those ratings are upper-middle grade.

Which just goes to show that credit rating redemption is possible.