Corporate credit quality in Canada took a turn for the worse in the first quarter of 2003 and the tone is likely to remain negative, based on both underlying economic fundamentals in Canada as well as the current rating outlook distribution, says Standard & Poor’s.

“Whereas the consumer sector has remained relatively resilient, the business sector has experienced some loss of momentum relative to a year ago, particularly in the manufacturing sector, even though overall corporate profitability still remains respectable,” S&P says in a new report. “Meanwhile, expectations for rising short-term interest rates — and a continued spread gap vis-à-vis the U.S. — has served to attract foreign investors back into Canada, with the increased liquidity and lower bond issuance volumes on a year-over-year basis propelling a narrowing in corporate credit spreads.”

In Canada, the bulk of the downgrades in the first quarter occurred in the telecommunications sector, which accounted for seven of 16 downgrades. Other sectors affected by the downgrades included forest products and building materials (three) and transportation (two).

But the rating agency says that downside risks to credit quality remain. Sectors that continue to show a relative high vulnerability towards further downgrades include utilities and insurance.

In the financial services sector, S&P has a negative outlook on the Canadian life insurance industry. Although the industry is considered to be among the most financially strong in the world, a number of challenges facing life insurers have led to the negative outlook. These challenges include; the continued pressure for insurers to increase their ROE, negative credit market trends, pressure on wealth-management businesses due to continued softness in the global equity markets, market overcapacity, and risk associated with industry consolidation.

The pace of rating downgrades picked up in the first quarter of 2003 compared with a quarter earlier: 16 downgrades and zero upgrades were recorded on debt outstanding worth $22.9 billion vs 14 downgrades and three upgrades in the fourth quarter and 48 downgrades and 15 upgrades for full year 2002. Globally, a total of 214 downgrades and 47 upgrades were recorded in the first quarter compared with 315 downgrades and 53 upgrades a quarter earlier. The rating actions in the first quarter affected long-term debt outstanding worth $549.7 billion in downgrades and $153.7 billion in upgrades.

By region, the quarterly tally of rating actions showed that credit quality deterioration slowed in the U.S. and emerging markets, but hastened in Europe and Japan on a quarter-ago basis.

The speculative-grade segment accounted for 69% of all rating actions in the first quarter. Speculative-grade downgrades affected four issuers from the telecommunications sector, but also included issuers from other sectors such as forest products and building materials, insurance and, transportation.