Last year was a turning point in the credit cycle, although the recovery has been weaker than expected, Dominion Bond Rating Service Ltd. says in a new report.

DBRS notes that downgrades continued to outpace upgrades by a significant margin of 2.7:1 in 2003, although this was significantly less than 2002’s and 2001’s ratios (4.7:1 and 4.3:1, respectively). Upgrades also increased in number, “suggesting less downward pressure in general, but also some actual recovery in credit profiles.”

The rating agency says that this recovery is probably as good as could be expected, in a year marred by political instability, currency movement, and the relatively weak global economic rebound. It notes that OECD predictions for 2004 growth are 3.0% (vs an expected 2.0% for 2003). “Such a recovery would not have a significant impact on credit profiles, but would be anticipated to stabilize existing ratings,” it says.

Rating changes are expected to continue improving, primarily as a result of reduced numbers of downgrades, it predicts. But upgrades are unlikely to increase significantly, “as there is not a significant enough economic improvement to make a significant difference in most companies1 bottom line credit profile.”

“In essence, 2004 will be a year of stabilization for some weakening credits… a cyclical improvement in the affairs of most companies should not result in upgrades as a more fundamental change must occur. Decreased buybacks of shares, fewer or smaller special distributions to shareholders, and improving business fundamentals should result in increased paydowns of debt,” it says. Many companies had weakened balance sheets, to inappropriately high levels of debt in some cases, all in anticipation of the ‘good times’ continuing. However, the ‘good times’ did not continue.”

DBRS says that its major concerns in 2004 are: the impact of the weakening U.S. dollar could be severe for a number of companies, either because they are dependent upon foreign operations and/or commodity price movements (particularly foreign companies selling commodities in now depreciated U.S. dollars); and, the renewed interest in mergers and acquisitions could result in significant new debt loads being taken on.

“DBRS is of the view that corporations generally see debt as much more acceptable in capital structures and, as a result, downgrades can be expected to outpace upgrades for the foreseeable future, although improved from the prior three years,” it concludes. “Only in periods of significant economic expansion can upgrades be expected to exceed downgrades. In the foreseeable future, more bad news than good news is expected on the credit rating front.”